If you’re ready to buy a home, you’ve probably spent a lot of time thinking about where you’d like to live and what kind of home you want to buy. One thing you may have forgotten is save for a down payment.
Most buyers finance their home purchase with a mortgage. But most loans require you to pay part of the purchase price in cash when you close the sale. This is called your down payment, and the amount you need depends on various factors.
How much should you save for a down payment? And is it possible to take out a mortgage loan without paying money for a deposit? These are the exact questions that this article will discuss in more detail.
What is a down payment?
A deposit is a one-time initial payment you make towards the purchase of your house. Although there are exceptions, you can expect to pay a deposit of between 5% and 20% of the purchase price. The exact amount depends on the type of loan you take out and other factors, such as your credit score.
First-time home buyers often struggle to get a mortgage approved because they can’t meet the down payment requirements. If you are trying to buy a $500,000 home, a 5% down payment would be $15,000. What if you plan to pay the full 20% deposit? It’s going to cost you $100,000. Having that kind of cash on hand is out of reach for many Americans.
And that figure doesn’t include closing costs, fees and the price of moving and furnishing a new home. That’s why some types of mortgages offer flexible down payment requirements.
How much should you save for a down payment?
A 20% down payment is ideal, but there are ways around it if it’s more than you can afford. The best place to start is to familiarize yourself with the different types of home loans and the requirements for each. This will help you determine which is the best option for you.
A conventional mortgage is not insured or guaranteed by the government, and usually requires a down payment at least 5%, although special programs allow low-income borrowers to buy with as little as 3% down. However, if you deposit less than 20%, you will need to purchase private funds mortgage insurance.
PMI protects the lender if you default on your mortgage. This does not protect the borrower and it can be quite expensive – from less than 0.50% to more than 2% of the loan amount, depending on your loan amount and your credit score.
You will usually pay mortgage insurance premiums with your regular mortgage payment. The insurance can be terminated once your loan to value ratio achieved 80%, which means you have reached 20% equity.
The Federal Housing Administration has been helping borrowers get low-cost mortgages since 1934. An FHA mortgage comes with low down payment requirements, low closing costs, and relaxed credit requirements.
If your credit score is 580 or higher, you may qualify for a mortgage with a down payment as low as 3.5%. If your credit score is between 500 and 579, you will need to pay a 10% deposit.
FHA mortgages are a good option for borrowers who have struggled with bad credit in the past. However, all FHA loans have an initial mortgage insurance premium of 1.75%, or MIP, plus an annual MIP that ranges from 0.45% to 1.05%, depending on your loan amount, duration of the loan and the amount of the deposit.
Borrowers who have deposited at least 10% can discontinue their MIP after 11 years or after reaching 80% LTV. With less than 10% down payment, you will pay MIP for the full term of the loan, regardless of the amount of principal you accumulate.
If you are a current service member, veteran, or surviving spouse of a veteran, you may be eligible for a VA loan. VA loans require no down payment and often come with very competitive rates. And while you won’t pay mortgage insurance, you’ll pay financing fees at closing or roll them into your loan. Fees are based on your loan amount, so you’ll pay less if you can make a down payment.
Before you can apply for a VA loan, you will need to obtain a certificate of eligibility. You can apply for a COE through your lender.
The United States Department of Agriculture guarantees home loans to qualified borrowers who want to buy a house in an eligible rural area. To qualify for a USDA loan, you must meet certain income and credit guidelines and ensure that the property you wish to purchase is in good condition and located in an eligible rural area or suburban Region.
USDA loans have no down payment requirements. So if you are a low income borrower looking to buy a house in a rural area, this might be a good option for you.
Benefits of saving a 20% deposit
Unless you plan to take out a government guaranteed loan specifically because it allows low or no down payment, you must be prepared to deposit 20%. Although it is possible to take out even a conventional mortgage at a lower cost, a 20% down payment has many advantages.
No private mortgage insurance
Lenders see borrowers with low down payments rather as a financial risk. PMI mitigates this riskand you will pay it until you reach at least 20% equity in your home.
keep in mind
PMI is notoriously expensive, and once you have it, it may take some due diligence on your part to get rid of it in case the lender doesn’t automatically discontinue it. You might find it worth avoiding the PMI altogether and taking the time to save up for a 20% down payment. If you have no choice but to subscribe to a PMI, make sure you know how and when to get rid of it.
Lower monthly payment
If you have a down payment of less than 20%, you can expect to pay a higher interest rate on your mortgage. So not only will you have to borrow more, but you’ll also pay a higher rate on that higher loan amount, which will increase your monthly payments and the total amount you’ll pay over the life of the loan.
Saving the entire 20% down payment will help you get a better rate and lower your loan amount, which will mean more affordable monthly mortgage payments.
Increased Chances of Mortgage Approval
Buyers who put 20% down are less likely to default on their loan, and this lower risk makes them more attractive to mortgage lenders. You may not need the boost of a large down payment if you have plenty of savings and a good credit score. If not, a larger down payment can improve your chances of being approved for a loan.
Build Instant Equity
The more you pose, the more equity you have upfront. This equity acts as collateral as it gives you a cushion in case you need to sell in a declining market, when your home might be worth less than you paid.
There’s no getting around it – even if you live in an area with an affordable cost of living, a 20% down payment is still a lot of money. And it can be very tempting to cut corners when saving for a home, especially if you have a lot of work against you financially.
A 20% down payment is not a requirement for most borrowers. However, there are many benefits to taking the time to save that money anyway.
Deposit 20% on your home could be the smartest, most profitable thing you can do as an owner. It may take time, but with a a well-thought-out savings strategy, it is totally doable. And the sooner you start saving, the easier it will be to reach your goal.
Home Buying Guides from GOBankingRates
This article originally appeared on GOBankingRates.com: How much should you save for a down payment on a house?