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2020 may be a good year for homebuyers
Whether you’re buying a house for the first time or the fifth, deciding how much money to put down isn't easy. While 20% is a good rule of thumb, there's no one-size-fits-all figure.
How much to put down on a house depends on the monthly payment you can afford, the cash you have in reserve and your plans for the home. If you expect to buy soon, here is what you need to know.
How much down payment for a house
is best?
There's no right amount to put down
on a home, but there are some
guidelines to consider.
"A 20% down payment is still highly
recommended because mortgage
insurance is not required with 20%
down," says Randall Yates, founder and CEO of The Lenders Network, an online mortgage marketplace. "The best interest rates are also given to borrowers with higher
down payments."
But many buyers put down much less. The median home down payment is 12% for all homebuyers and 6% for first-time homebuyers, according to the 2019 Profile of Home Buyers and Sellers from the National Association of Realtors.
That said, many mortgage lenders offer conventional loans with a down payment as low
as 3%.
What's more, some first-time homebuyer and government-backed mortgage programs allow you to qualify with no down payment.
As a result, the buyer is left to decide how much down payment is right. Your financial situation and goals for your home can guide you rather than rules of thumb or
lender minimums.
There are several factors to think about to choose the right down payment amount.
These include:
The monthly mortgage payment you can afford. The more money you put down, the lower the loan amount – and your monthly payments – will be. Because mortgage loans are typically so large, you will likely need to put down a lot to make a big difference.
If you have flexibility with how much you can put down, run some numbers to see the difference in your monthly payment and what's best for your budget.
Take this example looking at 3%, 5% and 10% down payments. If you put 3% down on a $250,000 home with a 30-year term and 4.5% fixed interest rate, your monthly payment for principal and interest would be $1,229.
With a 5% down payment, your monthly payment would drop by only $26. But if you increase it to 10%, you would pay $89 less per month than you would with 3% down, which can make a bigger difference over time.
Private mortgage insurance. It's not just the principal and interest that affect you, though. If you have a conventional loan, you could also be on the hook for private mortgage insurance, or PMI, unless you put down at least 20%.
PMI is designed to protect the lender if you can no longer make your monthly payments. If your loan-to-value ratio – the loan amount divided by the value of the property – is too high, the lender could lose money in foreclosure, even after selling the home.
PMI can cost between 0.55% and 2.25% of the original loan amount each year, according to the Urban Institute 2017 Mortgage Insurance Data at a Glance report. Once your loan-to-value ratio, or LTV, reaches 80%, the risk is low enough that PMI is no longer required.
If you can't afford a 20% down payment, PMI may be a given. And on some government-backed loans, mortgage insurance is required regardless of how much you put down. But if you can reasonably afford to avoid PMI, you may want to make a larger down payment.
Of course, you can get rid of PMI after you close on the loan if you get to the point where your LTV is 80% or lower.
"The bank will send an appraiser out, and if they evaluate the home and you have at least 20% equity," says Joelle Spear, a certified financial planner with Canby Financial Advisors in Massachusetts, "then they will simply remove (the PMI) from your account."
But the lower your down payment, the longer it will take to get to this point.
Interest rate. The more money you can put down, the less risk you pose to the lender. As a result, lenders may be willing to offer you a lower interest rate.
On the flip side, loans with low or no down payments are more accessible, but they can be more expensive overall.
"When a lender is financing 100% of the purchase price, they're obviously taking on greater risk," Yates says. "To offset that increased risk, lenders charge higher fees and interest rates."
Closing costs. As you're deciding how much money to put down on your next home, consider your closing costs. These costs typically amount to 2% to 5% of the house's price, and you can choose to either pay them upfront in cash or roll them into the loan.
If you're paying the closing costs upfront, that's money you won't be able to use for the down payment. But if you finance the costs, you will increase your monthly payment and total interest charges.
Talk with your lender to determine what your closing costs will be, and compare paying them over time with paying them upfront.
If you only have enough cash to meet the lender's minimum down payment, you may have no choice but to finance your closing costs. If you have the cash to cover the down payment and closing costs, keep in mind that your down payment may be less than you thought.
Emergency savings. The more money you can put down, the less you'll pay each month. But if you drain your savings account, you could set yourself up for trouble.
"Homeownership can be expensive, and often unexpected expenses can arise,"
Yates says.
If a major appliance breaks or you run into other emergency expenses, a zero balance in your savings account could mean using high-interest credit cards to bridge the gap.
And if your budget is already tight, those card payments could make keeping up with your mortgage and other monthly obligations challenging.
Saving between 1% and 4% of the value of your home every year for home-related expenses is a good goal. But when you first buy the home, you may want a larger buffer.
There's no right answer to the question of how much money you should have in savings. But consider keeping enough to give you the peace of mind to confidently move forward with buying the home.
Plans with the home. A loan program with low or no down payments can be appealing, but it could create an equity problem, depending on your plans and the housing market. If your home's value decreases, you could end up with negative equity, which means you owe more than your home is worth.
If you plan to stay in the home for a long time, the loan amount will decrease and the market value could increase again, fixing the negative equity problem. But sometimes plans change.
"If you end up having to move for a job or some other reason," Spear says, "you might be forced to pay the bank money when you sell the house instead of collecting equity."
You may be stuck in the home if you can't afford to pay the lender the difference between what the home is worth and what you owe.
Although not ideal, if you made a large down payment and have a fairly low LTV, a low home value won't ruin your finances. Home prices typically trend upward over time.
How to decide how much to put down on a house
Several national and local programs can help eligible buyers get into homes. But you typically have to meet program requirements.
Some programs are available only to low-income homebuyers. You may also need to live in the home you buy for a certain amount of time and meet other requirements. Otherwise, you'll need to repay the amount you received.
Whatever you do, avoid buying a home until you have a big enough down payment to afford it without draining your emergency fund.
Look into down payment assistance programs