How Much Should You Save for a Down Payment on a House?
If you’re ready to buy a house, then you’ve probably spent a lot of time thinking about where you’d like to live and the type of home you want to buy. But one of the biggest things most people overlook is saving for a down payment.
One of the advantages of buying a home in 2021 is that you can apply for financing and take out a mortgage. But most lenders will require you to pay a portion of the costs upfront. This is what’s known as your down payment, and the amount you need to save will depend on a variety of factors.
But how much should you save for a down payment? And is it possible to take out a mortgage without putting any money toward a down payment at all? Those are the exact questions this article will discuss in more detail.
What Is a Down Payment?
A down payment is a one-time upfront payment you’ll make to secure your mortgage. In general, you can expect to pay a down payment between 3% and 20% of the total cost of the home. These factors will vary depending on your credit score and the type of mortgage you take out.
First-time homebuyers often struggle to get approved for a mortgage because they can’t meet the down payment requirements. If you’re trying to purchase a $500,000 home, then a 3% down payment would be $15,000.
And if you plan to put down the full 20% down payment? That’s going to cost you $100,000. Having that type 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 certain types of mortgages offer flexible down payment requirements.
How Much Should You Save for a Down Payment?
If a 20% down payment is not financially possible for you, then there are ways around it. The type of home loan you qualify for determines the kind of down payment you’ll need to save for.
So the best place to start is by familiarizing yourself with the different types of home loans. This will help you determine what is the best option for you.
A conventional mortgage isn’t insured or backed by the government, and it usually requires a down payment between 3% and 20%. However, if you put down less than 20%, you’ll be required to purchase private mortgage insurance.
If at some point you’re unable to make your mortgage payments, PMI offers some protection to the lender. PMI can be quite costly and usually costs between 0.50% and 1.50% of the total mortgage.
You’ll either pay this as a monthly or annual fee, and you will have to continue paying for PMI until your loan-to-value ratio reaches 80-20.
The Federal Housing Administration has been helping borrowers secure 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, then you can qualify for a mortgage with a down payment as low as 3.5%. If your credit score is between 500 and 579, then you’ll need to put down a 10% down payment.
FHA mortgages are a good option for borrowers who have struggled with bad credit in the past. And this type of mortgage doesn’t require you to take out PMI.
If you’re a current service member, veteran, or surviving spouse of a veteran, you may be eligible for a VA loan. VA loans don’t require any down payment and you won’t have to take out PMI. And these loans often come with relaxed credit requirements and competitive rates.
Before you can apply for a VA loan, you’ll need to get a certificate of eligibility. You can apply for a COE through your lender.
The U.S. Department of Agriculture offers home loans to anyone who wants to purchase a home in an eligible rural area. To qualify, you must meet certain income guidelines and ensure that the property you want to buy is located in an eligible rural area.
USDA loans don’t have any down payment requirements. So if you’re a low-income borrower looking to purchase a home in a rural area, this could be a good option for you.
Advantages of Saving a 20% Down Payment
Unless you’re planning on taking out a government-backed loan, you should be prepared to put down 20% as a down payment. Although it’s possible to take out a conventional mortgage for less, there are many advantages to putting at least 20%.
No Private Mortgage Insurance
If you only have a 3% down payment, then lenders will see you as more of a financial risk. For that reason, they will charge PMI until you reach at least 20% equity in your home.
Keep in Mind
PMI is notoriously expensive and once you have it, it’s difficult to get rid of. You may find that it’s worth it to avoid PMI altogether and take the time to save up for a 20% down payment. If you have no choice but to take out PMI, make sure you know how to get rid of it.
Lower Monthly Payment
If you have a down payment that’s lower than 20%, you can expect to pay a higher interest rate on your mortgage. This means your monthly payments will be more expensive, and you’ll pay more over the life of the loan.
Saving the full 20% down payment will not only keep your rates low, but contributing more money will also cut down on the total principal financed. This will translate to more affordable monthly mortgage payments.
Increased Odds of Mortgage Approval
Some lenders will not even consider giving you a mortgage if you can’t contribute a 20% down payment. And if you’ve struggled with poor credit in the past, your odds of approval are even less likely. Saving up a 20% down payment will greatly increase your odds of getting approved for a mortgage.
Build Instant Equity
If you put down a sizable down payment on your home, then you build immediate equity. Your down payment will also act as a safeguard against any temporary market downturns because you’ll have more of a cushion if home prices decline.
The Bottom Line
There’s no getting around it — even if you live in an area with an affordable cost of living, a 20% down payment still adds up to a lot of money. And it can be very tempting to cut corners when you’re saving for a home, especially if you have a lot working against you financially.
If you’re able to qualify for a government-backed loan, then it may not be necessary for you to save for a 20% down payment. However, there are many advantages to taking the time to save up that money anyway.
Putting down 20% on your home is the smartest and most cost-effective thing you can do as a homeowner. It may take time, but with a well-thought-out savings strategy, it is entirely doable. And the sooner you start saving, the easier it will be for you to reach your goal.
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- Consumer Financial Protection Bureau. 2017. "How to decide how much to spend on your down payment."
- Consumer Financial Protection Bureau. 2017. "What is private mortgage insurance?"