Personal Finance

Home Loan Basics: Down Payment and Closing Costs

Apr 28, 2020

It’s time to dispel the misconception of a mandatory 20% down payment and explore the other options available to today's homebuyer. We’ll also review other costs associated with buying a home.

What is a down payment?

A down payment is the money you pay upfront when you buy something on credit. Lenders view a down payment as a way to reduce their risk. After all, if you’re willing to use your own money to purchase a home, it's more likely they won't want to default and lose your investment.

Plus, if you do default, the lender limits their loss by not being responsible for the entire purchase price. Typically, down payments vary between 3.5% to 20% of the purchase price of the home.

A few loan programs don't require any down payment at all. In 2021, the median down payment was 7% for the first-time homebuyer.

Alternatives to a 20% Down Payment

Although buyers can put down 20% or more as a down payment, many first-time homebuyers look for smaller down payment options. Options can vary by lender and loan program. Here are some well-known programs that accept smaller down payments.

Conventional Loan Programs — 3%

Conventional loans are a popular choice. Guidelines for these loans are set by the government-sponsored enterprises Fannie Mae and Freddie Mac, but they aren’t guaranteed or insured by any government agency. Although some of the loans under this program require a 20% down payment, others require as little as 3%.

For example, Fannie Mae offers programs that allow as little as 3% down for first-time homebuyers. They also offer a low down payment program called HomeReady®, which is available to both first-time and repeat buyers. The Freddie Mac Home Possible® program is similar, also offering down payments of as little as 3% for first-time buyers, repeat buyers, and retirees.

FHA Loan Program - 3.5%

The most well-known option for low down payments is the FHA loan, which has been around since 1934. Unlike conventional programs, these loans are insured by the Federal Housing Administration, a part of the U.S. Department of Housing and Urban Development.

Homebuyers enjoy down payments as low as 3.5% with the additional benefits of easier qualification, making it a popular choice for many first-time homebuyers.

VA Loan Program - 0%

The VA loan program has an option for no down payment. The increased risk to the lender is reduced under this program because the VA guarantees a portion of the loan. In addition to no down payment, VA loans also provide more favorable terms to buyers. This includes no requirement for mortgage insurance, even when doing less than a 20% down payment.

However, eligibility for this type of loan is limited. Borrowers generally need to be active service members, veterans, or surviving spouses to be considered eligible for a VA loan.

USDA - 0%

The U.S. Department of Agriculture (USDA) offers home loan programs that don't require a down payment. The Section 502 Guaranteed Loan Program and the Section 502 Direct Loan Program help low- and moderate-income borrowers purchase homes in rural areas.

Some loans are provided directly by the USDA Rural Development while others are financed through private financial institutions and guaranteed by the USDA.

Closing Costs

Down payments aren’t the only upfront expenses when purchasing a home. There are also closing costs. Depending on the loan type, these can be paid by the buyer or the seller.

When a loan is referred to as a no-closing-cost mortgage, the borrower doesn't pay the cost at the closing of the loan. Instead, the costs are added to the loan amount or traded for a higher interest rate. The closing costs are then paid over the life of the loan instead of in one large sum.

The exact closing costs you pay depend on many factors, including the location of the property, the loan program used, the size of your down payment, and the lender you select. Within three days of receiving your loan application, the lender will provide you with a Loan Estimate.

In addition to the estimated interest rate and monthly payment, your Loan Estimate provides total closing costs. Then three days before your loan closing, you'll receive a Closing Disclosure with the final amounts of the closing costs.

Here’s a breakdown of what to expect with the Loan Estimate. We’ve included more details about the specific expenses later in this article.

Section A – loan origination charges from the lender, such as origination fees, rate buydowns, and processing fees; these costs vary from lender to lender.
Section B – loan related services that you can’t shop for, such as credit reports, flood certifications, document preparation, and appraisals; these vary from lender to lender.
Section C – title, escrow, and closing fees; depending on your state, you may be allowed to shop for these services but in many states, the seller will select the company who handles the services.
Section D – the total projected loan costs from sections A, B, and C.
Section E – any recording fees and government taxes charged by your state, county, or local authorities; the amount won’t vary between lenders.
Section F – prepaid insurance, loan interest, and property taxes; the amount won’t vary between lenders.
Section G – the funds needed to establish your escrow account; this is typically required if you have a down payment of less than 20% but is otherwise optional. The amount won’t vary from lender to lender.
Section H – labeled as other, this section typically just includes an owners title insurance policy; in most states, this is paid for by the seller and the amount of this fee won’t vary from lender to lender.
Section J – this section will show any lender credits, which may include a rebate price associated with your rate or any promotional credits that the lender may provide; these will vary from lender to lender.

Expenses Related to Down Payment

Depending on the type of loan you select and the amount of your down payment, you could be required to pay for a type of insurance that protects the lender or to pay a fee related to the loan program.

Conventional Loan PMI

Private mortgage insurance is provided by a private insurance company to protect the lender. It’s typically required for conventional loans when the down payment is less than 20% of the purchase price.

The cost of PMI often falls somewhere from 0.5% to 2% of the total loan amount but it can vary based on loan type, loan amount, and lender. It may be paid as a monthly premium, a one-time upfront premium, or a combination of the two.

FHA Funding Fee

Under the FHA loan program, you pay an upfront mortgage insurance premium (MIP) of 1.75% in most cases. You also pay an annual amount that ranges from 0.45% to 1.05% — depending on the loan term, down payment, and loan amount.

For example, if you take out a 30-year mortgage and put 3.5% down on a loan amount of $350,000, the annual MIP will likely be 0.85% of the loan amount.

VA Funding Fee

If you purchase your home through the VA program, you’ll typically pay a VA funding fee. This is a one-time fee that can be paid at the close of your loan or added to your loan amount. Because this fee varies depending on several factors, your lender will refer to the funding fee chart provided by the VA to calculate an exact amount.

For example, if you’re purchasing your first home with no down payment, the chart reflects 2.3% of the total loan amount as the fee. There are some instances related to service and disability in which the fee can be waived.

USDA Loan Guarantee Fee

Generally, you can expect two guarantee fees to be applied by the lender under the USDA loan program. One is an upfront guaranteed fee up to 3.5% of the total loan amount. The other is an annual fee of up to 0.5% for the life of the loan. Based on USDA guidelines, your lender will calculate the exact amounts of each fee for you.

Expenses Related to Your Loan

There are also expenses that are specific to the loan process. These fees vary by lender, loan product, and borrower, and sometimes go by different names.

For example, an administrative fee, application fee, origination fee, and processing fee are all related to the processing of your loan. Generally, a lender will only apply one of these fees.

Administrative Fee: A charge by your lender to cover the expenses of processing your loan.

Application Fee: A charge by the lender to process your loan application.

Attorney Fee: In states where required, a charge by an attorney to prepare your home purchase documents.

Broker Commission/Broker Fee: The fee paid to a mortgage broker, if you choose to use one.

Credit Report Fee: A charge by the lender for obtaining your credit reports from Experian, Equifax, and/or Transunion.

Courier Fee: A fee to have a courier deliver your loan documents.

Discount Points: A payment to the lender to reduce the interest rate on your loan.

Document Preparation Fee: A fee charged by the lender to prepare the legal documents required for your loan.

Lock Extension: A fee charged by the lender to extend the how long your interest rate will be available, aka locked in.

Notary Fee: A fee to have a notary assist with the signing of your loan documents.

Origination Fee: A fee charged by the lender to process your loan application.

Prepaid Interest: A charge by the lender for the accrued interest on your loan until your first payment.

Processing Fee: A fee charged by the lender to verify the information from your application and create the necessary documents for your loan.

Recording Fee: A fee charged by a government agency to record the purchase of your property.

Underwriting Fee: A fee charged by the lender to assess your ability to repay the loan.

Wire Transfer Fee: A charge to cover the expense of wiring funds.

Closing Costs Related to the Property

Here are common charges related to the property itself, with some slight variations depending on how your state assesses taxes.

Appraisal Fee: A charge for an appraiser to assess the value of the property and provide a report to the lender and you.

Flood Certification Fee: A charge to determine if the property is located in a flood zone. If it is, flood insurance will be required by the lender.

Home Inspection Fee: A fee you pay to have a professional inspection of the property before you purchase it.

Homeowners Insurance: The prepayment of the first year's insurance premium on the property.

Lender's Title Insurance: A one-time charge by the title company to protect the lender if a dispute should arise around ownership of the property.

Owner's Title Insurance: The premium for a policy that protects you if someone challenges your ownership of the new property.

Property Taxes: Your portion of the property taxes that are prorated to you based on the property sale date.

Title Search Fee: A fee charged by the title company to review public records for any ownership issues related to the property.

Transfer Tax: A tax by a government agency to transfer the title to the buyer from the seller.

Today, many borrowers achieve their dream of owning a home sooner through low down payment and first-time homebuyer programs.

The mandatory 20% down payment on a home is an outdated myth thanks to today’s low down payment and first-time homebuyer programs.

Becoming familiar with the common closing costs connected to a home loan also helps you budget for your purchase. Details of these expenses are available in the Loan Estimate form provided by the lender after an application is completed. The final amounts of these closing costs will appear in the Closing Disclosure form sent to borrowers three days before loan documents are signed.

You can rely on the experienced mortgage professionals at Axos Bank to provide the guidance and support you need when you are ready to explore home loan options. Call 888-546-2634 to speak with an experienced mortgage specialist today.