Any person who has already bought a house in the past and paid a down payment knows how hard it is to pay that much cash in one go. It is not easy for every individual to save a lot of money.
Figuring out how much down payment to put on the house? You will need to understand the basics related to a down payment and how it factors into the process of house buying.
Defining the Down Payment
The down payment is a “cash payment” that you give to the seller at the time of closing when you purchase a house. Your lender provides the remaining amount of the purchase price.
A percentage calculates the down payment value. For example, if you’re purchasing a house for $250,000 and your down payment is 20% of the purchase price, the down payment would be $50,000. A 10% down payment would be $25,000 of the purchase price.
Some mortgage programs don’t require a down payment, however in the majority of cases, you’ll be required to have a stake in the investment.
How Much Should You Put Down on the House?
How much you should pay on a down payment is a personal choice. It depends mostly on your financial condition and what mortgage program you will be using.
If you’ve saved a good amount of cash over time or received money unexpectedly by luck, you’re already ahead of the game. But, if you’re beginning, it might take you months or even years to accumulate money for a down payment. Moreover, there are a few costs during the closing to consider.
Several mortgage programs permit you to pay 0% as a down payment whereas others require a 3% down payment for a conventional mortgage loan. However, there’s a drawback: lenders usually charge a higher interest rate to minimize their risk, which means that you have to pay more in interest over the period of the mortgage with these lower down payment options.
When you pay more as a down payment, you’ll get a lower monthly loan payment and a lower loan-to-value (LTV) ratio. The LTV ratio plays a vital role in the approval of your mortgage. It also enables you to determine your borrowing amount from the lender.
The Myth of 20% Down Payment
The impression that you have to pay 20% as a down payment to get a mortgage is false. There are many more alternatives than you think.
If you pay less than 20% as a down payment, you’ll be a riskier borrower for lenders, and that’s where mortgage insurance comes into play. You will have to pay for a mortgage insurance policy if you make a down payment of less than 20%. This mortgage insurance protects the lender against the projected risk due to the lower down payment. Therefore, if you are unable to pay back the mortgage and face foreclosure, the insurance policy will reimburse the lender for their financial losses.
However, having mortgage insurance is expensive, but in most cases, you can cancel it after getting at least 20% equity in your house.
A higher down payment can also make you eligible for a larger loan and secure a lower interest rate. Your offer will be considered “strong” by the seller if you put down a higher down payment.
The Average Down Payment on a Home
Depending on the buyer, location, and house prices in that particular region, the average down payment on a home may differ. For instance, buyers who are buying a house for the first time put less cash as a down payment than buyers who are purchasing their second or third homes. This is because they can use money from the sale of their last home to make their next home’s down payment.
Generally, the average down payment on a house is 13%, and for first-time buyers, it’s at 7%, as per the National Association of Realtors’ 2018 Profile of Home Buyers and Sellers.
Perhaps you have already decided how much you want to put in down. Below is a look at the minimum requirements for some common types of mortgages.
Different Mortgage Programs and Their Minimum Down Payment Requirements
3% to 5% – Conventional Mortgages
The companies, Fannie Mae and Freddie Mac drive access to U.S mortgage credit. These companies don’t lend money by themselves, but they do provide backup to programs offered by conventional lenders. If you want to qualify for special programs with 3% down payments, you may have to meet certain income requirements and geographic location requirements.
Other types of conventional loans require a down payment of 5% to 15%. You will have to get Private Mortgage Insurance (PMI) when you put a down payment of less than 20% in other types of conventional loans.
Your credit score, the size of down payment and the loan amount determines your PMI’s monthly cost. You will have the option to waive the PMI requirement, in return for a higher interest rate.
3.5% – FHA loan
The minimum down payment is 3.5% for a loan protected by the Federal Housing Administration (FHA). This means you will get the FHA’s maximum financing offers at 96.5%, and you will need a minimum credit score of 580.
If your down payment is 5% or more, FHA will charge lower costs. One of the critical differences between loans with PMI and FHA loans is that FHA does not charge people with lower credit scores more.
There’s a significant disadvantage of paying less than 10% down on an FHA mortgage. You cannot cancel your annual mortgage insurance premiums. You’ll be paying those premiums for the life of the mortgage or until you sell or refinance.
0% – VA and USDA
For most of the veterans of the armed forces, VA loans are available, and in select rural areas, there are also USDA loans available. You can see which areas are eligible for USDA loans using maps available on USDA’s website.
You borrow from a regular lender in both loan types. However, the VA or USDA guarantees the loans, and you, therefore, have to pay a guarantee fee.
A Down Payment You Can Manage
If you are confused by all the options for down payments, you are not the only one.
Remember your down payment can include your savings along with monetary gifts received from relatives and grants from local governments or your employers. You have to provide the source of the down payment to your lender in the documentation.
It’s vital to make sure that you’re not diminishing your retirement savings account or your contingency reserves to purchase a house. If you’re doing that, you might be at a disadvantage to secure your future retirement. Furthermore, using your contingency reserves is also not the best thing to do, as you might need to make expensive repairs after you move into your new home. Worse, you might run into a financial crisis, and you won’t have that safety cushion to fall back on.
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