The down payment for your first house is easily the most significant challenge that prospective homebuyers face.
Working hard to save a large sum of money can take years, and it can cause frugality fatigue.
While most lenders typically only require a 5% down-payment for first-time buyers, it’s worth the extra effort and time to save up at least 20% to put down.
What exactly is a down payment for your first home?
A down-payment is a large sum of money that you pay upfront when you purchase a home. You may have put a down-payment on a brand new vehicle or other large purchase in the past.
You may be familiar with paying money upfront before making a big purchase. It’s a percentage of the total principal of your home.
- Suppose you want to put 5% down on a home that costs $350,000. Your down-payment amount would be $17,500.
Typically, a lender will take into account the percentage of the down payment into the approval process, and the down payment is considered your initial ownership stake in your new home.
It shows the lender that you’re committed to purchasing the property. Once you’re approved, they’ll fund the remainder of the purchase price.
Down payment requirements vary by lender
As mentioned, most lenders will require at least 5% down, but the more, the better. Some government-backed loans include Veteran’s Affairs Loans and USDA Loans don’t require any down payment at all for qualifying applicants.
A significant benefit to having a 20% down payment is that you’re not limited to any of these loan options.
You can choose whichever one has the best rates, and you’re not hindered by the percentage required upfront.
What are the benefits of having at least 20% down?
Between your down payment and your credit score, the higher they both are, the better your chances are of getting a great interest rate.
The lower your interest rate means the less you’ll spend on your mortgage overall. Having a high down payment will also help you avoid paying mortgage insurance.
Taking advantage of a low or no down payment option is inviting. It means that you can become a homeowner sooner than you would if you’re working hard to save every extra dollar.
As much as the instant gratification of immediate home ownership is attractive, financially speaking, there are plenty of benefits to saving more before taking the plunge.
Private Mortgage Insurance
When you have 20% of your mortgage saved up, it looks fantastic in the eyes of the lender and immediately identifies you as a lower risk.
When you have the minimum down payment, you’re not privy to the same benefits. The risk is already mitigated since the mentioned no or low down payment options are backed by government funding.
However, with the government-backed loans, you pay extra fees and mortgage insurance, which you pay until you have 20% of the principal paid.
Private mortgage insurance is a safety net for lenders just in case you default on your loan. It can be between 0.58% to 1.86% of the loan.
The price of your monthly mortgage insurance will depend on the cost of your home, the downpayment amount, your interest rate, and your insurance rate.
Depending on your circumstances, you could be looking at an additional $150 per month or an additional $600.
The total amount of your downpayment determines your loan-to-value ratio by lenders. Along with your credit score and your debt-to-income ratio, LTV helps a lender decide whether or not you qualify for a mortgage.
The LTV ratio is the amount left owing on the property after your down payment is paid. It’s a percentage that shows the ratio showing the owing balance and the home’s appraised value. The higher your down payment, the lower your ratio will be (from CNN).
- The exact formula is the mortgage amount ÷ the appraised value of the property or purchase price (whichever is the lower value) = LTV.
Suppose you want to purchase a home for $200,000. The appraised value of the home is $205,000. Your loan amount will be based on the purchase price because it’s the lower value.
- You have $50,000 for a down payment, which means your mortgage needs to be $150,000. The LTV equation would be $150,000 ÷ $200,000 = 0.75. Multiply that by 100 to get a percentage of 75. Your LTV is 75%.
Saving yourself money
Not only does having a 20% down payment help you avoid mortgage insurance and increase your chances for better interest rates, but it saves you money in the long run.
You’ll immediately have a lower mortgage balance than if you were to make a lower down payment or take a no down payment option. A lower mortgage balance means that you’ll have lower monthly payments.
Many people stretch themselves too thin when they want to become a homeowner and take on too much house that they can’t afford. It’s essential to ensure you can be comfortable in your budget because being a homeowner comes with plenty of extra costs and emergency expenses that you should have a separate savings account for.
Over the entire 25 years of your mortgage, paying a larger down payment will save you some interest charges. You’ll also typically be offered a better interest rate than if you were to put down the minimum amount.
Ways to get your down payment for your home
There are a few ways to get a down payment for your home, but diligently saving is the best way financially.
Even though it may take you a bit longer to become a homeowner, it’s worth it.
Other methods include:
- Take a personal loan. It may not be the most financially sound. If you have virtually no debt and taking a personal loan won’t hinder your credit or debt-to-income ratio, a personal loan may get you into your dream home a bit faster.
- Downpayment assistance. There are plenty of state-specific buyer programs that offer assistance, or you could borrow from friends and family.
- Pull from your 401K.
- Sell valuable assets.
Why Should You Shoot for 20% Down on Your New Home?
While everyone’s financial situation is different, and circumstances will vary among individuals, a larger downpayment for your first home is the best decision you can make for your long-term financial goals.
Putting down 20% or more down means less interest over the length of your mortgage, lowered mortgage payments, and it will open up your options during the house-hunting process.
However, while you want to put the most money down, you don’t want to leave yourself without extra funds during the home buying process because some unexpected expenses may pop up. Overall, aim to put down the most amount of money, but leave yourself some breathing room.
To read more on topics like this, check out the Financial Tips category