One of the first things people do when thinking about buying a house is start to save for their down payment. Traditionally, a down payment is 20% of the purchase price of a house, intended to show the lender that you will be responsible for the property (as well as to save you money on interest). However, there are some things you should know about how down payments work today.
1. There Are Programs With Less than 3% Down
In fact, if you qualify for a VA Loan or a USDA Rural Loan, you may even be able to get into a program that requires 0% down. Many programs for first-time home buyers require 3% to 3.5% down. All of these low interest rates are generally for those who intended to occupy their home, rather than for investors who are looking for rentals.
All of this means that you don’t necessarily need 20% down to purchase a home. If you’re in a good market, purchasing a home sooner might actually be more beneficial, as home prices may increase fast enough to compensate for the additional costs.
2. Payments Less Than 20% May Require PMI
One reason you may want to pay at least 20% is that many mortgages require “private mortgage insurance” (PMI) if you pay less than 20%. This is an additional fee intended to protect the lender against default. FHA loans will have PMI for the life of the loan, while some other loans will simply have it until you cross the 20% threshold with your payments.
3. Your Down Payment Must Be Properly Sourced
You need to have a lot of documentation regarding where your down payment comes from. Your down payment cannot come from a source other than regular income unless you have a letter stating that it is a gift.
This is because mortgage lenders generally don’t want to see you borrowing money for your down payment, as this subverts the point of a down payment (which is to ensure you have a direct stake in the property). If family members or friends don’t give you a clear letter stating that the money they gave you is a gift, it could actually be a loan.
4. Down Payments Are Only One Cost
Down payments are only a single cost out of many. You’ll experience a number of closing costs, ranging from loan origination fees to home inspections. Due to this, you’ll need more than just the down payment saved.
Your mortgage company can give you an estimate on your closing costs, generally calculated based on the approximate price of the property that you’re interested in purchasing. You should have a buffer saved in the event that unexpected costs arrive.
5. Bigger Down Payments Lead to Bigger Houses
The larger down payment you have, the more you can usually afford to borrow. As an example, a bank may see that you can support a loan of $200,000. If you put down $5,000, the bank can only offer you $205,000. But if you put down $50,000, the bank can offer you up to $250,000.
Eventually, you may be able to “roll over” one house into a larger house, upgrading through the virtue of the equity you have in your current home. This is an excellent strategy to build wealth over time.
Ultimately, it’s usually better to have more rather than less when it comes to a down payment, but it may not be worthwhile to continue waiting until you have 20% if you can qualify now. Want to learn more about down payments? Continue to follow HomeMortgage.com.