Quite possibly one of the largest purchases you’ll ever make is your home. The only thing that comes close is your vehicle, and generally speaking, you’re not shelling out the same kind of dollars over such a long expanse of time when you’re buying a car.
Not only is the entire house the most money you’ll likely ever spend, but the down payment is as well. There are a lot of requirements out there and reasons to put down more or less money when you’re buying a house.
When it comes down to it, how much you put down is a personal choice based on your needs, financial situation and goals. There’s a minimum, sure, but the amount you end up putting down is up to you.
Let’s take a look at how much down payment you need to buy a house and why you might consider putting in a bit more.
What is a Down Payment?
This is an obvious question with an equally obvious answer. A down payment is simply the amount of money you pay upfront when you buy and finance a house.
Generally, this money come about in two ways. Often, the money will come straight from your bank account. You can’t borrow a down payment so you need to pay cash. The other, and often more common way, is by pulling your down payment from the proceeds of a previous home sale.
There are a lot of reasons to pay a larger down payment if you can afford it. First, it can lower a number of the closing fees and the ongoing fees as your loan matures.
Second, a larger down payment immediately puts equity into your home. This means the cash value of your home is immediately worth more than it is.
Finally, a larger down payment can lower your monthly payment. You need to borrow less money and therefore, you won’t have to repay as much, lowering what you’ll pay every month.
I’ve heard 20% – Is that Legit?
Generally speaking, for your normal mortgage loan, yes. You’ll want to put down at least 20% because this allows you to realize some significant savings.
Most banks and even the federal government requires you to carry private mortgage insurance (PMI) on any mortgage that is under 20%. PMI is insurance that pays off your loan if you end up defaulting.
It’s not insurance that you ever get to take advantage of and, worst of all, it can be a nice chunk of change every month. It does not contribute to your principal or interest; it’s just on top. This can make your monthly payment much higher than it normally would be.
Some lenders will help pick up the PMI for you and allow you put down less than 20%. For the service, they’ll generally charge a percentage fee on top of your loan. So for example, if a lender offers you a 30-year, fixed rate mortgage loan at 3.5%, they may offer to pay your PMI for you if you agree to pay 4%.
20% is a Lot – What about Other Options?
There are a variety of other options available to you if you don’t want to pay 20% up front. In fact, you can buy a home for as little as 0% down. There are some very specific programs that can help you with your down payment.
The Department of Veterans Affairs offers zero down payment loans based on entitlements. This means that the government guarantees a certain amount of your loan if you default, generally about $36,000.
Lenders will often write a mortgage for four times this amount, meaning that you’re getting about 25% down on a $144,000 loan. There are also bonus entitlements which link to home values in a given area. This is also factored in to how large of a loan you can get. If you are a veteran or active-duty service member, be sure to do your research to determine what’s right for you.
USDA Home Loan
If you’re moving to a rural area, the United States Department of Agriculture offers a program to low- and middle-income borrowers to qualified rural areas.
Fannie & Freddie Loans
Fannie Mae and Freddie Mac offer loans with down payment requirements as low as 3% as well as closing assistance for first-time home buyers with strong credit but little capital for a down payment. This can be a great option for consumers who need or want a home but can’t swing the large upfront cost. Note, that you will likely still have to pay PMI.
Local grants and programs
States and even towns offer a number of different programs from tax credits all the way up to mortgage payment assistance for moving into certain areas.
So How Much of a Down Payment do I Need?
It can be exceptionally tempting to go for the lowest down payment option. It gets you into the home you want with some money in your pocket to get all the fun things like televisions and furniture.
But be wary. A lower down payment means that you’ll likely have to pay a higher monthly payment. This can put a strain on your finances month to month. It also likely increases the amount you’ll pay over the life of the loan.
Moreover, lower down payments come with requirements like mandatory courses and financial education classes, private mortgage insurance and more. Lower down payments make you a higher risk to lenders. They will ensure that they are appropriately compensated for that risk.
Lenders are required to disclose any fees that you pay as well as the full cost breakdown of the mortgage, with a repayment schedule. Do your research and shop around.
You may qualify for an FHA loan that only requires 3% down, but is that a good idea? Does it make more sense to wait a year or two so you can build your credit & put down more?
Only you can answer these questions to make the right decisions for your financial future. In many cases you only need 3% down to get into a house, but make sure that’s what you want.