If you’re ready to buy a house, 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. One thing you might’ve overlooked is saving for a down payment.
Most buyers finance their home purchase with a mortgage loan. But most loans require that you pay a portion the purchase price in cash when you close the sale. This is what’s known as your down payment, and how much you need depends on a variety of factors.
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 make toward the purchase of your home. Although there are exceptions, you can expect to pay a down payment 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 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, a 5% 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?
A 20% down payment is ideal, but there are ways around it if that’s more than you can afford. The best place to start is by familiarizing yourself with the different types of home loans and the requirements for each. 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 of at least 5%, although special programs let lower-income borrowers buy with as little as 3% down. However, if you put down less than 20%, you’ll be required to purchase private mortgage insurance.
PMI protects the lender in the event you default on your mortgage loan. It does not protect the borrower, and it can be quite costly — anywhere from less than 0.50% to over 2% of the loan amount, depending on your loan amount and credit score.
You’ll typically pay mortgage insurance premiums with your regular mortgage payment. The insurance can be discontinued once your loan-to-value ratio reaches 80%, meaning that you’ve reached 20% equity.
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. However, all FHA loans have a 1.75% upfront mortgage insurance premium, or MIP, requirement, plus an annual MIP that ranges from 0.45% to 1.05%, depending on your loan amount, loan term and down payment amount.
Borrowers who put down at least 10% can discontinue their MIP after 11 years or after reaching 80% LTV. With less than 10% down, you’ll pay MIP for the entire loan term, regardless of how much equity you build.
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 they often come with highly competitive rates. And while you won’t pay mortgage insurance, you will pay a funding fee at closing or roll the fee into your loan. The fee is 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’ll need to get a certificate of eligibility. You can apply for a COE through your lender.
The U.S. Department of Agriculture guarantees home loans to qualified borrowers who want to purchase a home 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 want to buy is in good condition and located in an eligible rural or suburban 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 specifically because it allows low or no down payment, you should be prepared to put down 20%. Although it’s possible to take out even a conventional mortgage for less, there are many advantages to a 20% down payment.
No Private Mortgage Insurance
Lenders see borrowers with low down payments as more of a financial risk. PMI mitigates that risk, and you’ll 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 can take some due diligence on your part to get rid of it in the event the lender doesn’t discontinue it automatically. 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 and when 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. So not only will you have to borrow more, but you’ll also pay a higher rate on that larger loan amount, which will drive up your monthly payments and the total amount you’ll pay over the life of the loan.
Saving the full 20% down payment will help you qualify for a better rate and reduce your loan amount, both of which translate to more affordable monthly mortgage payments.
Increased Odds of Mortgage Approval
Buyers who put 20% down are less likely to default on their loan, and that lower risk makes them more attractive to mortgage lenders. You might not need the boost a big down payment gives if you have plenty of savings and a great credit score. If that’s not the case, a larger down payment can improve your chances of being approved for a loan.
Build Instant Equity
The more you put down, the more equity you have right off the bat. That equity acts as a safeguard because it gives you a cushion in the event you need to sell in a declining market, when your home might be worth less than you paid for it.
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.
A 20% down payment isn’t a requirement for most borrowers. However, there are many advantages to taking the time to save up that money anyway.
Putting down 20% on your home might be 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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- Freddie Mac. "Maximum LTV/TLTV/HTLTV Ratio Requirements for Conforming and Super Conforming Mortgages."
- Fannie Mae. 2021. "ELIGIBILITY MATRIX."
- Rocket Mortgage. 2022. "What Is PMI? Private Mortgage Insurance Defined And Explained."
- Chase. "What is PMI and how is it calculated?"
- Congressional Research Service. 2022. "FHA-Insured Home Loans: An Overview."
- U.S. Department of Veterans Affairs. 2022. "VA funding fee and loan closing costs."
- American Financing. "Buying a Home with Bad Credit and a Big Down Payment."