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Regardless of the amount of your mortgage, you must at least save some cash as a down payment for your loan. Historically, the norm was that purchasers should put down 20% of the purchase price. That's a fine figure to go for, but if the house is pricey, or your resources are limited, it might not be possible. So, what exactly is a down payment and how should you determine how much is right for you?
What is a Down Payment?
A down payment is the upfront payment made initially when buying a home. The money is derived from your own savings or legitimate gifts. Making a down payment protects both your new home and you as the buyer. If you wish to sell the house and the market fluctuates, you may be indebted more than the property value. If you put down a larger down payment you may even make money in the future when you sell the home.
Benefits of a Larger Down Payment
A Lower Home Loan Balance
A larger down payment equals a lesser loan amount to begin with, which comes with certain benefits. One of these advantages is that it provides a buffer of home equity, despite the decrease in the housing market values. It creates the difference between refinancing or being able to sell your house in the future.
Lower Mortgage Interest Rates
Mortgage lenders normally assess risk using the loan to value (LTV) ratio method. A lower down payment would mean a higher LTV ratio and as a result, the riskier your mortgage seems to lenders. To compensate for riskier loans lenders often charge higher interest rates. A larger down payment decreases your loan's LTV ratio hence a lower interest rate for you.
Manageable Monthly Payments
A larger down payment drastically lowers your monthly payments going forward. It not only makes your future financial management easier but also relieves you of the stress that comes with conducting your monthly budgeting.
Reduced Private Mortgage Insurance Premium
Mortgage insurance protects borrowers who are unable to repay their debts. The risk of defaulting on mortgage loans is higher in those loans with greater LTV ratios. The amount of your down payment will determine the value of mortgage insurance you must pay, the payment duration, and how much your premiums are.
Less Interest Expense
A lower loan balance and interest rates combine to minimize the total interest payable over the entire life of the loan. A mortgage calculator will give you the total interest you will have to pay, allowing you to understand if a larger down payment is what you need.
What is Considered a Large Down Payment
How much is considered a large down payment depends on where you live and the home price range. A large down payment could be 20% or more of the purchase price in certain areas if your credit score is low and your income is high enough.
A large down payment can mean different things depending on where you buy and what kind of mortgage you get. With FHA loans, for example, it means paying no more than 3.5 percent of your gross income toward a set monthly mortgage payment for 30 years when buying an average-priced home (not including closing costs).
What it Means Down the Road
If you're planning to buy a home, it's important to understand what a large down payment means down the road. A large down payment is one that's over 20 percent of the purchase price.
The higher your down payment, the less risk you have in the event of an unforeseen problem with your credit history or finances. Because you've put more money into your home, you're much more likely to stay in it if something goes wrong.
Considerations When Putting Less Than 20% Down
Buying a home with less than 20% down will require a larger mortgage and may require more interest payments over time. It can also mean that you will be required to pay more in property taxes and insurance than you would with a larger mortgage. If you want to get this kind of loan, it's important to know what your options are and how much money it will cost.
1. Type of Mortgage Loan You Are Looking For
There are three main types of mortgages:
Conventional: These loans require a minimum of a down payment of as low as 3% of the home value if your credit history is excellent.
Government-Insured Loans: Government-backed loans such as FHA, USDA, and VA are among the mortgage programs that need the least down payments.
- If your credit score is 580 and above, you will only need a 3.5% down payment for FHA loans.
- Borrowers who qualify for VA loans can obtain mortgages with zero down payment (100% LTV)
- Borrowers eligible for USDA loans may also borrow at zero down (100% mortgage loan)
Jumbo Loans: These loans pose a greater risk to the lenders and hence require a down payment of between 10% to 20%
2. Credit History
If you have a poor credit score, you can use an alternative loan program that offers lower interest rates and better terms than regular mortgages. These include jumbo loans, VA loans, and small business loans.
3. Whether You Can Afford the Monthly Payments
While it's technically possible to buy any house with less than 20% down, it may not be feasible if you're going to be unable to make the payments in full each month or if there are other financial responsibilities that will take away from your income (such as student loans).
4. Are You Willing to Pay Mortgage Insurance?
Before opting for anything less than 20% down on your house, it makes sense to consider the cost of mortgage insurance that you'll have to pay if you go this route. Mortgage insurance is typically around 3% of the loan amounts per year and can add up quickly if you're paying it every year and especially if you go for a larger amount of over $1M.
Bottom Line
The amount you pay as a down payment for a new home is a practical and personal decision. To determine the amount you should spend, consider other debts you may have, your monthly budget, and your living cost. A competent mortgage provider can assist you in determining the correct amount for you. Remember that a down payment isn't the only price you'll pay before getting the keys to your new home.
We at First Savings Mortgage provide great loans with exceptional service. Contact us today to allow one of our expert loan officers to guide you through the process of determining how much you can afford for your new home.
Please note, by refinancing your existing loan, your total finance charges may be higher over the life of the loan.