Buying a home is a major expense and it often requires that buyers borrow money in the form of a mortgage. Mortgages, however, usually require a down payment that you will pay upfront as a condition to receive the loan. Keep in mind that this payment will be the first bit of equity you will have on the home your purchase.
Saving for a down payment is not an easy task. For many home buyers, it’s actually one of the biggest obstacles to home ownership. Keep in mind that your down payment, income, debt, credit score, and credit history will greatly impact your qualification.
A common myth in real estate is that you need 20 percent down to qualify for a mortgage. While 20 percent down would be ideal, it actually isn’t that common. In fact, the average down payment for first time-home buyers is around 6%. For repeat buyers, the average is 14 percent of the purchase price. Additionally, there are sometimes instances in which a down payment may not even be necessary.
Why 20 Percent?
Well the real answer to this question is that a down payment between 3 and 20 percent of the home’s sale price will typically qualify for a conventional 30-year fixed loan. However, there are some benefits to having a 20% down payment for this type of loan.
First, it gives the lender greater confidence and improves your chances of receiving an approval for the loan. Additionally, being able to afford a large down payment means that you
- Will Not Have to Pay Private Mortgage Insurance (PMI)
- May Qualify for a Lower Interest Rate
- Will Have a Lower Monthly Payment
Again, saving a large down payment is certainly a challenge, but waiting too long to save, will only make things more difficult. Remember that house prices are always on the rise in the LA market, so waiting will only cost you more money in the long run. Also, don’t forget that your down payment does not include other expenses such as closing costs.
Low or No Down Mortgage Options
While most banks and lenders would like you to have 20 percent down, you can find government programs that require far less money upfront. A federally-backed loan is subsidized by the government and therefore protects lenders against defaults. It is precisely this guarantee, which makes it possible for lenders to offer lower interest rates.
Federal Housing Administration
A Federal Housing Administration (FHA) loan accepts a 3.5 percent down payment. FHA loans also have lower credit score requirements. If you have a good credit score, some will even allow you to carry a higher debt-to-income ratio. While this program helps those who cannot qualify for a conventional loan, buyers will need to pay mortgage insurance. This insurance protects the lender in case you default on the loan. The insurance costs 1.75 percent of the mortgage amount. Also, there is also an annual premium of 00.85 percent of the mortgage. As an example, if you were to borrow $100,000, the premium would amount to $850 per year or $70.83 per month.
Federal National Mortgage Association
The government also sponsors mortgages through the Federal National Mortgage Association (Fannie Mae) The two most popular Fannie Mae loans are the Conventional 97 and the HomeReady mortgages. While they both have a minimum down payment of 3 percent, there are different eligibility requirements for both.
Conventional 97 mortgages are for home buyers who have good credit but do not have a large down payment. The HomeReady program is designed specifically for low- and moderate-income borrowers. As such, these loans will finance homes in minority, low-income, and disaster-impacted areas.
Department of Veterans Affairs
The Department of Veterans Affairs offers programs that do not require any money down. This program is only for active/retired service members, as well as some members of the National Guard and Reserves.
While private lenders originate the loans, the VA guarantees them. Unlike FHA Loans, these loans do not require mortgage insurance. The borrower will generally need to pay a funding fee, but there are exemptions (i.e., disability rating issued by the VA). The funding fee can be included into the mortgage amount so you don’t need to pay anything out of pocket. This fee varies between 1.25 and 3.3 percent.
What’s the Right Down Payment for You?
At this point you’re probably wondering whether or not you should put down 20 percent or 3 percent? What about zero down? The answer to this question is not as easy as you may think.
Choosing a lower down payment makes you a bigger risk and the lender will need to protect their investment by means of mortgage insurance and fees. As mentioned earlier, you may pay an upfront fee and an annual fee. The fees are part of your mortgage payment, so you may consider them to be a worthwhile trade off.
Again, some programs don’t need mortgage insurance, but they do charge an upfront guarantee or funding fee. The worst part of having a low down payment is actually the higher interest rates. Any buyer considered to be a risk will pay a higher interest rate for the life of the loan. This could prove very costly when including insurance and annual fees. So, while a low down payment may seem to be the most appealing option, you must account for all charges.
Keep in mind that all lenders are required to disclose every fee. Be diligent and get information from multiple banks and lenders. Additional research and comparison shopping can save you thousands of dollars.
Don’t Forget to Save For Expenses After Closing
Many homebuyers can become overly focused on their down payment and forget to set aside money for a rainy day. Many financial advisers suggest that you have at least three months of mortgage payments in your savings account. Not having additional savings could leave you in a financially comprised situation if you lose your job or need to make repairs.