Mastering the Art of the Down Payment

Writing a payment check can be unsettling, especially when you are handing over your life savings in one shot. Before you pay for your house deposit, you have to save and save – and saving up enough money to put a down payment for your house isn’t easy. But how much will you need? While lenders prefer a 20 percent down payment, most homebuyers put down much less. You can actually put a 3.5 percent down payment through a U.S, FHA (Federal Housing Administration) loan, which is a 30-year fixed interest rate mortgage.

A 3.5 percent FHA down payment is usually capped at $417,000 for home mortgage loans. However, this will depend on where the house is located. If you’re purchasing a house in a high-income area like New York, you may have to pay a higher down payment. Conventional banks can approve your home loan with a down payment of 5 percent for mortgages of up to $417,000. If the mortgage size is above $417,000, then your lender may request an additional 5 percent down payment.

Why is paying a 20% down payment a good thing?

While you can purchase your home by paying as little as a 3 percent down payment, there is an upside in paying a 20 percent down payment. Some of the benefits include:

Lower interest rates: Putting a 20 percent down payment will prove to your lender that you’re financially stable and you’re a good credit risk. When your financier has more confidence in your ability to repay the loan, they will most likely offer a lower interest rate.

You will be paying less for your home: The higher your down payment, the less your mortgage amount. For instance, if you’re purchasing a home for $200,000 with a 20-percent down payment, the remaining loan balance will be $160,000. However, if you pay a 5 percent down payment, you will have a $190,000 balance. Keep in mind that interest rates add up with high mortgage loans.

Your offer will stand out: According to Forbes, most home sellers prefer buyers who offer a 20 percent down payment or more. Remember, you will be competing with several other Americans who have a dream of owning a home. A 20 percent down payment gives sellers the same confidence as banks. They see you as a stronger buyer whose mortgage loan application is more likely to be approved.

You won’t pay for a Private Mortgage Insurance: When you make a large down payment, your lender will see you as a good risk, and you may not have to pay private mortgage insurance (PMI). Those who put a lower down payment are considered as a higher risk, and lenders may require them to pay monthly mortgage insurance.

Put a reasonable down payment

ValuePenguin approximates that 90 percent of Americans buying homes as their primary residence get a mortgage to make the purchase. Lenders typically want to see low debt, a good income, strong credit, and reasonable down payment. Although there are good reasons why you should strive for a 20 percent down payment for your home, it’s not a requirement. Saving up for a 20 percent deposit in the current tough economy where wages have remained flat for years while home prices have skyrocketed makes it challenging to put a 20 percent down payment. In fact, most first-time homebuyers pay a 6 percent down payment, according to a recent survey by the National Association of Realtors.

If you don’t have a 20% down payment, don’t worry. There are other options that can help you purchase your dream home. If you’re able to raise at least 5% down payment, you can get a conventional mortgage loan as long as you have a reasonable credit score between 660 and 700, adequate income, and a reasonable debt-to-income ratio. In case you don’t have the 5% down payment, or you don’t meet the other lender requirements, you can get a mortgage loan through a federally backed program. Examples of these programs include the FHA (Federal Housing Administration), the Department of Veterans Affairs, Fannie Mae and Freddie Mac, and the USDA.

Mortgage insurance makes sense

Don’t confuse private mortgage insurance (PMI) with mortgage protection insurance (MPI). PMI is an insurance policy that protects your mortgage lender from losses in case you default from paying your mortgage. On the other hand, MPI is a type of life insurance that protects you in case you become disabled or die with a mortgage balance. Your MPI provider will pay the mortgage balance directly to your lender.

With low-interest rates and affordable home prices, now is the right time to purchase your home. PMI enables you to access the housing market quickly by allowing you to pay a down payment below the recommended 20%. Because PMI protects lenders, it gives them the confidence to approve your mortgage even with a smaller down payment or a low credit score.

Seek down payment assistance

While purchasing a home is exciting, the main barrier is the down payment. Results from a recent survey indicated that 61.7 percent of millennials cannot afford a down payment to buy a home. Fortunately, there are down payment assistance programs that can ease you into the home-buying process. These programs may be administered by lenders, a local or state housing authority, or a nonprofit organization.

Those who qualify for down payment assistance can get money to cover the down payment or closing costs. The funds received through the program can be a grant, debt, or an interest-free loan that you pay off in the future. One of the requirements to qualify for down payment assistance is that you live in the home and use it as your main residence for a specified period.

Maximizing your home down payment makes sense – the bigger your down payment, the lower your interest rates and monthly bills, and the better your chances of building equity quickly. However, a sizeable down payment on your home could leave you without enough funds to maintain your home or money to do other things. There is no one-size-fits-all down payment amount. Deciding the right down payment is a personal decision that involves balancing the advantages of a large down payment against the need to have some money for emergencies and making essential upgrades.