Saving money is essential to preparing for a home purchase, even if you intend to take out a mortgage. There are various fees involved in that purchase, and we cannot forget about the down payment.
So, how much do you need to set aside for the down payment on your mortgage? The answer to that question is contingent on several factors. Let’s take this opportunity to dive into those different factors so you can make a more informed decision regarding your home purchase.
Why Is a Mortgage Down Payment Necessary?
A typical home buyer does not take on the full price of a property using the money they have put away in their savings account. Instead, most buyers turn to lenders for financial assistance. They take out mortgages, so they do not need to foot the entire bill.
Before a lender approves your loan, they may require you to complete the down payment. The lender will deny your mortgage if you cannot make the payment. That is the main reason why a down payment is necessary.
Beyond that, completing the down payment also benefits buyers because it affects the terms of the loan. You may have a more favorable mortgage based on your down payment.
How Much Will My Down Payment Cost?
It is time to discuss the question at the heart of this article. How much will your down payment cost? As we hinted at in the introduction, the size of your down payment will hinge on several factors. Chief among those factors is the type of mortgage you use to cover your home purchase.
Down payment requirements vary from one loan type to the next. Learn more about your likely down payment requirement by reviewing each mortgage option.
Your first loan option is known as a conventional mortgage. A conventional mortgage is any home loan that is not directly backed by a government agency. These loans are available from banks, credit unions, and private lenders.
Some buyers prefer conventional mortgages because they offer greater flexibility and higher loan amounts. You may be able to purchase a more expensive using this mortgage compared to the alternatives. The funds for conventional loans may also be released faster.
Down payments for conventional mortgages span a wide range. They may be as low as 3% and climb all the way up to 20%.
A lender may require you to provide a 20% down payment if you are taking out a jumbo loan. Jumbo loans are subtypes of conventional mortgages often used to cover expensive home purchases.
Remember that down payment requirements for conventional mortgages are not set in stone. If the initial down payment the lender asks from you seems a bit high, you can try to negotiate that number down. A substantial down payment does not necessarily have to derail your dreams of homeownership if you are willing to make some concessions elsewhere.
Federal Housing Administration Loans
We are now getting into government-backed mortgages and starting with the Federal Housing Administration (FHA) loans. Although the government guarantees an FHA loan, you do not actually get it from an agency. Instead, the money comes from a typical conventional mortgage provider, and the FHA insures it.
Many home buyers seek out FHA loans because they have fewer demanding requirements. You can have a lackluster credit score and financial issues in your past and still receive approval for an FHA loan. On top of that, these FHA loans can offer favorable down payment options.
Your down payment requirement will depend on your credit score. The down payment requirement for an FHA loan may be as low as 3.5%. A borrower must have a credit score of at least 580 to secure that type of loan. That is a relatively easy bar to clear, given the credit score requirements attached to conventional mortgages.
Taking out an FHA loan remains possible even if your credit score is only around 500. You must offer a larger down payment representing at least 10% of the property’s price.
United States Department of Agriculture Home Loans
Next, let’s get into home loans without down payment requirements. We can start with the mortgages offered by the United States Department of Agriculture’s Rural Housing Service, otherwise known as USDA home loans.
According to the United States Department of Agriculture, USDA home loans are designed to help low and very-low-income applicants secure decent, safe, and sanitary housing.
USDA loans are available to borrowers who do not have decent, safe, and sanitary housing. Borrowers must also show they cannot obtain loans from other providers while demonstrating the capacity to take on a mortgage. You must also be allowed to participate in federal programs to take advantage of this offer.
Aside from those requirements, USDA loans can only be used in eligible rural areas. The property you are purchasing cannot be utilized in income-producing activities.
Purchasing a property using this type of loan is an enticing proposition, especially if your current living situation is bordering on dangerous. The lack of a down payment requirement may also help you buy a new home faster.
United States Department of Veterans Affairs Loans
Lastly, you can also pay for your new home using a mortgage backed by the United States Department of Veterans Affairs. These mortgages are more commonly referred to as VA loans. Like with USDA loans, down payment requirements are not attached to these mortgage offerings.
VA loans are already attractive because they do not require applications to make down payments. On top of that, these loans also come with low interest rates and limited closing costs.
However, the Consumer Financial Protection Bureau notes that most applicants must pay a VA loan funding fee. The funding fee is usually around 1 to 3% of your loan. Even with the funding fee accounted for, you can still save more money on your home purchase by opting for a VA loan.
Of course, only a small segment of the population can take out these mortgages. VA loans are given to service members, veterans, National Guard, and reserve members. Members of certain organizations may also be deemed eligible for a VA loan.
You can also apply for a VA loan if you are the surviving spouse of a veteran, the spouse of a veteran missing in action, or the spouse of a veteran currently being held as a prisoner of war.
How Much Should My Down Payment Be?
After exploring your options and determining that you are ineligible for VA or USDA loans, you have decided to take out a conventional mortgage. You settled on a conventional mortgage after seeing that the limit for FHA loans cannot cover your desired property.
Now that you have decided to get a conventional mortgage, you may choose from different down payment options. You can afford to put down a substantial payment because you have done a good job saving money. Your lender may also be willing to offer a down payment closer to 3% because of your stellar credit score.
So, which option should you choose? Should you opt for a lower down payment or something higher?
The Case for a Lower Down Payment
Choosing a lower down payment makes sense for a few reasons.
For starters, you can use the money reserved for your down payment on other necessary expenses. Spend the money you save on your down payment to pay for some new furniture and other additions that will make your new home feel more accommodating.
You can also set aside the money for emergencies. With a mortgage added to your monthly expenses, you may have a tougher time saving money. Having the money left over from your down payment fund for emergencies would be helpful.
The Case for a Higher Down Payment
Paying more than you must to complete a home purchase may seem counterintuitive. Still, there are real benefits from such a decision.
First, a lender may give you a lower interest rate if you make a larger down payment now. Over the long run, you can save more money on your purchase thanks to that low-interest rate. Lenders become willing to offer that because they know there is minimal risk of you defaulting on your mortgage payments.
Speaking of mortgage expenses, those will also likely be lower because you are providing a substantial down payment. You will have an easier time making ends meet every month because your financial obligations are lighter.
Think of that larger down payment as an investment in future purchases. You can already make headway to cash-out refinancing or a home equity loan because you are claiming a significant stake in your new home right from the start. Those funds can then go toward your children’s education or other sizable expenses.
Do not immediately dismiss the idea of making a substantial down payment because it could be the right move.
Use the information here to better prepare for your down payment and move closer to home ownership. We at RI Home Store can also help you along that path. Contact us today, and let’s talk more about your home buying and down payment plans!