Guide to Down Payments
What is a down payment exactly, anyways? In simple terms, the down payment is the percent of the cost of your new home that you pay out of pocket when you purchase the home. The rest of the cost is typically covered with a loan called a mortgage.
Lenders offer a wide variety of different mortgage plans, with different minimum down payments required. Minimum down payments traditionally range from 10% to as much as 25% of the total home purchase price. Generally, higher down payments equal lower mortgage rates, and the more you put towards the down payment, the less you’ll have to pay interest on when repaying the loan, so you’ll save money in the long term even though the upfront cost is higher. Lower down payments also typically result in large monthly payments, or in extremely long mortgage plans that risk leaving you in debt for decades. However, a smaller, more affordable down payment can help if you have trouble saving, and allow you to move into a house much sooner than if you spent several years sinking money into an apartment.
Most experts will recommend a down payment of at least 20% of the total home cost, to qualify for better rates and to avoid having to pay private mortgage insurance, also known as the PMI. Private mortgage insurance protects the lender from the risk of you defaulting on your loan, and is only asked for at lower down payments. If you have good credit, you can get a loan with as little as 10% down, but while your equity is below 20 to 22% paid off you’ll have to pay an extra 0.3% to 1.15% of the total loan in interest towards PMI. Buying before you’ve saved up the full 20% can still save you a good bit of cash when compared to renting, but be careful not to rush into a home that is more expensive than you can reasonably afford in the long-run.
How to afford the upfront cost still becomes a thorny issue for most families just starting out. The average price of an existing or pre-owned home in 2016 was $276,900, according to the National Association of Realtors. This puts the recommended down payment (20%) for an average pre-owned home in 2016 at $55,380, with the minimum down payment (10%) at $27,690. Even more cost-effective homes can be expensive enough for a 10% down payment to be cost prohibitive – explaining a recent survey by NerdWallet’s finding that on average we spend three years saving up for a new home. Fortunately, some banks have specific plans to help you save money, and several sites have online tools to help you calculate whether to rent or buy and when, depending on your credit score, your savings, your monthly rent, home cost, and potential mortgage plans.
Several places also offer down payment assistance programs, and government-backed mortgages are an option for some. The Department of Housing and Urban Development‘s pages for individual states have links to programs to assist prospective homeowners. There are also a variety of locally run assistance programs you can seek out. Both federal and state programs can change over time, so simply take advice from a magazine or online source, you’ll need to research these programs so that you are up to date on all the current options. For mortgages, currently the two most common options are Federal Housing Administration mortgages and Veterans’ Affairs loans. FHA mortgages may require as little as 3.5% for the down payment, while veterans may be able to receive a loan from the VA for 0% down. FHA mortgages are available to anyone who meets the income and credit score requirements. VA loans are available to veterans and their families who meet minimum credit score requirements.
Establishing a savings plan to accumulate enough for a down payment can be an effective tool to help you structure your budget and plan ahead. Some banks even offer workshops or special services on savings relating to home ownership. Ask around, since you never know what programs may be available in your area. Remember too that your “dream home” likely won’t be your first purchase, and one of the worse mistakes new homeowners can make is to buy a home whose mortgage payments, upkeep, insurance, and taxes collectively outstrip your income. A licensed realtor can be a valuable asset in helping to determine what is a reasonable range, and thereby how much of a down payment you’ll need to save. In most cases, families are better off with a smaller home and large down payment, compared to a minimal down payment on a large house they can’t afford in the long run.