One of the biggest barriers to home ownership is the down payment. Many people want to own homes but aren’t able to afford the 20% down payment they think they need to have to buy. But, the truth is down payment amounts actually fluctuate greatly depending on various factors, and this means homeownership might be closer than you think.
Here’s what you need to know about making down payments and how you can determine how much home you can afford.
What Is a Down Payment?
A down payment is the amount that you pay on a house upfront when you buy it. This is your commitment to the home seller that you are serious about the deal and signals the commitment you are about to make to your financial lender.
A down payment is typically paid out-of-pocket, while the remaining value of the home is paid over time through a mortgage. When most people talk about saving up for a home, they mean that they want to save enough to have a down payment and have the financial stability to make reoccurring mortgage payments.
While a down payment is usually a percentage of the total home cost, there is no direct number to what you will pay. It all depends on your current financial situation, the overall housing market, the price of the home, and your loan situation. The focus of this article will be to guide you through these various elements to determine the right down payment for your home buying goals.
The 20% Down Payment Myth
Traditional wisdom is that you need at least a 20% down payment to buy a house. This means that if you want to buy a $200,000 house, you need $40,000 minimum to have a down payment.
What some call a rule of thumb, others call a myth. The Street reports that many mortgages and loans, particularly by the U.S. Federal Housing Administration (FHA), only require a 3.5% down payment on a 30-year fixed-rate home mortgage. While there are some limitations to this, it means that your down payment for a $200,000 home would only be $7,000. That is much more affordable for most homeowners, who could then use the money they saved on a down payment to cover closing costs, agent fees, home improvements, and other expenses.
Knowing that you only need to may a minimum of 3.5% on a down payment for the house may be a relief for some, but that doesn’t mean it should be your financial goal. There are significant benefits to increasing your overall down payment.
Benefits of Larger Down Payments
The down payment that you have on-hand is a statement of your financial security, and your mortgage provider and other financial lenders will base their offers on what you can provide upfront. A larger down payment can result in lower interest rates, lower monthly payments, and reduced mortgage insurance costs – saving you money and making your mortgage request more appealing to various banks.
When a financial lender offers you a mortgage, they are taking a risk that you might not pay that loan back. The riskier the mortgage, the higher the interest rates and insurance costs. A lower down payment (among other factors like your income and credit history) is one warning signal to increase the level of risk.
Using the $200,000 house example again. If a homeowner pays $40,000 in a down payment, then the bank only has to provide $160,000 to the home seller. However, if the homeowner can only offer a $7,000 down payment, then the bank is on the hook for $193,000. These payments will take longer and there is an increased chance that the homebuyer will have problems paying the house off – increasing the risk to mortgage insurers as well.
Plus, if you have a large down payment, you pay less interest. When you put $40,000 down (on a $200,000 home), you only pay interest on the remaining $160,000. When you put $7,000 down, you pay interest on $193,000. A larger down payment will save you a significant amount of money in interest costs.
This means that it may be more financially viable to save for a larger down payment instead of opting for the smallest one.
Benefits of Smaller Down Payments
That being said, there are benefits to opting for smaller down payments. Paying less upfront means you can buy a home sooner. You won’t have to save up for several years until you can get the full 20%.
Using a smaller down payment also means you will have other funds for remodeling or emergency savings in the event that you need money immediately. This will make you more financially secure than if you were to clear out your savings entirely for a down payment.
Each homebuyer has their own unique financial needs and values, and this will determine how much they can afford in a down payment.
Ask Your Realtor® About Down Payment Expectations
If you are buying a house for the first time, it’s important to work with a real estate agent who can help you understand the process and find a house that is the right fit for your budget and down payment. Work with a Realtor® who specializes in helping first-time homebuyers so they can guide you.
Use the system at EffectiveAgents.com to find the right person for the job. Our data-backed algorithm makes it easy to sort and find Realtors® who meet your needs. With their help, you can make strong home-buying decisions that fit for your home needs and budget.
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