Down Payment Basics – Conventional and FHA Loans

*Disclaimer – Loan guidelines change often and may have changed; be sure to consult with your lender about current requirements.

There are many factors to consider when deciding on the type of loan to use when purchasing a home. Understanding the differences in down payment requirements plays an important role in forming your home buying strategy. These differences are items such as the amount of the down payment required and what source of monies are allowed. Understanding these differences will put you on the right path in deciding the proper loan for you.

The Amount of Down Payment Required
As of 2011, conventional loans require a minimum 5% down while FHA requires 3.5%. Be careful though, as closing costs and escrow funds (monies for taxes and insurance), if not paid for by the seller, would be in addition to the down payment. For example, let’s assume the purchase of a $200,000 home for each of these types of loans:

Conventional – $200,000 purchase price X 5.00% required down = $10,000
FHA – $200,000 purchase price X 3.50% required down = $ 7,000

On a typical purchase, closing costs and escrow monies typically range from an additional 1% to 5% of the purchase price ($2,000 – $10,000), depending on the loan program, points charged, and cost of insurance and taxes on the property. Both loan types require providing documentation regarding the source of all monies paid at closing.

Documenting Funds to Close – Why does the lender require this?
Regardless of loan type, your lender will need to verify that you have the funds necessary to pay for the down payment, closing costs, and escrows. The reason the lender requires this proof is to ensure that the borrower didn’t take on additional debt in order to come up with the required funds; this ensures that the debt ratio used to qualify the borrower hasn’t changed.

Types of Funds Allowed
Bank Accounts – The most common source of funds comes from bank or credit union accounts (checking, savings); be careful though, as the lender will typically require one or even two months’ proof, such as all pages of bank statements, that you had access to these funds. For example, putting a large deposit into one of these accounts during the loan process won’t satisfy underwriting, and additional documentation as to where these monies came from will be required.

Gift Funds – Conventional lending is more restrictive regarding using gift funds than FHA. For example, conventional rules state the borrower must meet the required minimum down payment on their own, regardless of whether there’s a gift, unless the gift is 20% or more. For example, using the $200,000 purchase price again, the borrower would be required to put a minimum of $10,000 of their own money down unless the gift is $40,000 or more and at least $40,000 of the gift is used for the down payment. FHA, on the other hand, allows for all or a portion of the 3.5% down payment to come from a gift.

Additionally, be sure to carefully review whether the person giving the gift is eligible to make the gift. While direct family members are eligible, other persons, such as the seller or loan officer, aren’t allowed to gift monies. If you’re fortunate enough to have someone interested in providing you monies for your down payment, make sure your lender will allow the use of these funds.

Retirement Accounts
Although use of retirement funds is allowed under both programs, there are tight restrictions and additional documentation that would be needed. You will be required to not only document that you have access to these funds, but in addition, you will need to disclose the terms of any payments associated with withdrawing those monies. For example, let’s assume you desire to pull $10,000 from your 401(k) account for a down payment. Most of the time you will have to do so in the form of a loan to yourself and an associated payment schedule would be created to replenish these funds. That new payment would now figure into your debt ratio, so be careful that this new payment doesn’t impact your loan qualification.

With proper planning, meeting either conventional or FHA down payment guidelines can be easy. Remember, you’ll need to know both how much and what type of monies are allowed in order to meet guidelines, so speak to your lender to ensure your down payment plan is sound.