Tips and Advice on a Down Payment on a House
In this article, we will take a look at how to afford a down payment for a home, including what a down payment is, how much is required by lenders, how much you should save, and some great ways to save up for a down payment.
What is a Down Payment for a Home?
If you are looking to purchase a home with a mortgage, you may be aware that lenders require that borrowers provide an initial lump-sum payment to secure the loan. Known as a “down payment”, the amount that lenders require is related to the amount that you choose to borrow - the bigger the loan, the bigger the down payment required.
How Much of a Down Payment Do I Need?
To secure a down payment for most conventional mortgages, the buyers typically needs a minimum of 5% of the purchase payment. For government loans (such as VA loans and FHA loans), the minimum can be as low as 3.5%.
These are minimum down payments for loans, but they do not guarantee that you’ll qualify for a loan. Depending on your income, credit score, price tag of the property, and other factors, you may need to put down more.
Furthermore, loans below 20% require additional costs that increase the long-term payments that buyers will be obligated to pay private mortgage insurance. For FHA loans, the equivalent cost is called mortgage insurance premium (MIP). The types of insurance add to the cost of the loan amount, generally amounting to 0.5 - 1% of the loan amount annually. These charges do expire when you’ve paid down 80% or more of the loan.
Instead of paying the minimum, most lenders and real estate experts agree that 20% is the ideal minimum to secure a mortgage loan. Having at least 20% avoids the aforementioned PMI/MIP charges, while also giving more favorable loan terms.
Remember, when a lender lends money to a borrower, they do a risk-assessment beforehand through factoring in your credit history, annual income, and other factors to figure out if you can pay back the loan. Lower down payments suggest that the person taking out the loan may be incapable of paying back the loan in full and may risk a foreclosure. Therefore, having your credit and finances in check beforehand can drastically reduce the cost of a loan’s interest rate and other charges.
How Much Should I Save for a Down Payment?
For most Americans, saving for a down payment can be a challenge due to its large expense. Having 20% of a home on hand can price many people out of the market. For instance, to afford a $150,000 home, it would take $30,000 to secure a mortgage. Additionally, this substantial down payment doesn’t include closing costs or other expenses related to being approved for a mortgage and purchasing the home.
For those that can’t afford this substantial amount, choosing a lower down payment for slightly less-favorable terms can be a smart decision. For example, putting down 3.5% through a VA/FHA loan for that same $150,000 home is only $4,500 - a much more achievable amount for many prospective homebuyers.
That being said, every decision regarding homeownership should be made on both short-term and long-term factors. For example, you may need a home in the near-future for your growing family. If you’re expecting a windfall or an inheritance from a family member that is terminally ill, for example, you may want to get housing sooner than later.
Greats Ways to Save for a Down Payment
Saving up for a down payment takes planning. The following are just a few of the ways that individuals are able to save money for a down payment:
- Save money regularly: Taking our previous $150,000 house as an example, if you wanted to save up $30,000 for the 20% down payment, saving $1,000/mo would take 30 months (2 years 6 months) to achieve. At 10% for only $10,000, this same mortgage may be had within 10 months.
- Consider putting your money into a CD (certificate of deposit). CDs enable you to save money while earning a percentage annually (usually around 1% or less). This may not seem like a lot, but your money grows versus just putting it in a savings account.
- Use retirement plans as sources for down payments. If you have a retirement account (ex. 401(k), 403(b), IRAs), you can choose to withdraw funds before retirement to finance your home purchase. Doing so may incur an early withdrawal penalty of up to 10%, but the value of a home may be a worthwhile investment for the future.