First Home Down Payments: What’s the Magic Number?

Home Ownership Young attractive couple in their 20's standing by the fence in front of woman's apartment building, talking and laughing on an early summer evening in the city

If you’ve been saving for a down payment on your first home, you probably have a financial goal in mind — an amount you’re hoping to save before homeownership can become a reality. But deciding on that magic number can be a confusing process. Most people think of 20 percent as the gold standard down payment amount, but many factors may influence the right down payment percentage for you. Here’s what you need to know.

Different Loan Types, Different Requirements

Your down payment applies directly toward the principal — your home’s purchase price. Therefore, the loan amount will only be for the remaining balance, which means you’d pay interest on a smaller amount. The less you put down, the more interest you’ll pay on a higher loan balance.

However, not all loans are built the same. Depending on the loans for which you qualify, you may be able to buy a home with a down payment lower than twenty percent. Here are a few common loan types available today:

  • Conventional Loans

Conventional home loans are mortgages that aren’t federally backed. If you’re a first-time homebuyer with a credit score of at least 620 and you’ve saved up money for a down payment, you may be a good candidate for a conventional mortgage loan. Conventional loans generally require a down payment anywhere between 5 and 20 percent.

  • FHA Loans

Federal Housing Administration (FHA) loans make purchasing a home accessible to people who might not otherwise be able to qualify for a home loan. FHA loans require a low down payment — a minimum deposit of 3.5 percent of the purchase price — and a relatively low minimum credit score.

  • USDA Loans

USDA home loans are available to eligible homebuyers in rural and suburban areas and are backed by the United States Department of Agriculture. If you have good credit and you meet specific income requirements, you may be able to skip the down payment altogether.

  • VA Loans

You may also be able to qualify for a home loan with a small down payment — or none at all — if you qualify for a VA Loan. These loans are only available to active members or veterans of the U.S. Armed Services.

Down Payments and Monthly Mortgage Payments

Your down payment can also influence your interest rate. A more substantial down payment not only lowers your loan-to-value ratio, but it can signal to the lender that you’re less of a risk, making them more likely to offer you a lower interest rate.

If you can only afford a small down payment, you may also have to pay an additional insurance premium called mortgage insurance. Lenders designed mortgage insurance to protect themselves if a buyer defaults on their loan.

If you put down less than 20 percent with a conventional loan, you may be required to pay private mortgage insurance (PMI). You’ll pay this premium monthly, usually as part of your mortgage payment. PMI premiums are calculated based on several factors, including:

  • Size of your down payment
  • Your credit score
  • The insurer’s policies

Standard PMI premiums are between 0.3 and 1 percent of the mortgage amount. Once you’ve built 20 percent equity in the home, you can apply to drop your PMI.

Bigger May Not Be Better

Many first-time home buyers don’t realize that purchasing a home comes with up-front costs. Before you put your life savings into a down payment, research the costs that come with buying a home and make sure you’ll have funds available to cover them. Here are some of the most common costs that come along with buying a home.

  • Closing Costs

Closing costs are typically between 2 and 5 percent of the price of the home and include fees for things like loan origination, appraisals, title searches, insurance, and credit report inquiries. If you’re buying a house at the U.S. median home cost of $320,000, you could pay up to $16,000 in closing costs.

  • Earnest Money

Earnest money is a deposit that lets the seller know you’re serious about your offer. The earnest payment is typically between 1 and 3 percent of the purchase price of the home, but it can be as little as $1,000. If the sale is successful, you can apply that amount toward your closing costs.

Buyers and sellers negotiate the terms of this payment, including its amount and any conditions. In a competitive market, a bigger earnest payment may make your offer look better or act as a tie-breaker between two offers.

  • Home Repairs

Unless you’re buying new construction, your home will probably need repairs, improvements, or changes soon after you take ownership. These updates can be anything from a new refrigerator to a kitchen renovation.

Keep some cash on hand above and beyond your down payment and closing costs. Even a good home inspector can miss big problems; as the new homeowner, you’ll be responsible for the repairs and maintenance costs.

  • Moving Expenses

It’s easy to focus on the costs of buying a house so much that you forget about the logistics of moving into it. Whether you’re moving across town or across the country, prepare for the cost of renting a truck or hiring a company to do the moving for you. If you’re moving out of a rental home, you may have additional costs, especially if your lease is not up when you leave.

 

The right amount for a down payment on a home is different for everyone. Your credit score, income, location, available cash, and even the cost of the house are all factors to consider. While a higher down payment could save you money in the long run, it might be wise to hold onto some of your cash for other home buying expenses.

 

This blog post does not constitute, and should not be considered a substitute for legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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