December 23rd, 2014 8:18 AM by Jackie A. Graves, President
When you are saving money for your first home,
it can be daunting to think about how much cash you will need to become a
While there are FHA-insured
loans that require just 3.5% for your down payment, those loans require you to
pay mortgage insurance for the life of the loan, which will keep your monthly
payments higher. Most conventional lenders offer home loans with either a 10%
or a 20% down payment, although some lenders offer loans requiring as little as
You will need to consult
with a lender to evaluate your individualized loan options, but before you do
that, you should consider the pros and cons of various down payment scenarios.
Why a 20% Down Payment Is
Ideal for Lenders
Mortgage lenders evaluate
your credit profile, your debt-to-income ratio, your job history and your
assets to make an educated guess about whether you will manage to repay your
loan responsibly. A 20% down payment is viewed as ideal by lenders
because you are investing a significant amount of your own money in your home
and therefore the lender’s risk is reduced.
If you make a 20% down
payment, you won’t have to pay private mortgage insurance.
PMI provides insurance to the lender in case you default on your loan.
Buyer Advantages of 20%
In addition to eliminating
the need for PMI, a 20% down payment will qualify you for a slightly lower
interest rate than a borrower who makes a smaller down payment. Another benefit
is that you will borrow less money, making your monthly payments smaller.
In addition, you will
instantly have 20% equity in your home, which you can borrow against in the
future or get back as part of your profit when you sell.
On the other hand, keep in
mind that 20% of the average home price in the nation ($200,000) is $40,000. It
can take years to amass that much cash and you will need additional cash for
closing costs, cash reserves in case of an emergency and moving costs.
In the meantime, home
prices may have risen and interest rates may have gone up, both of which will
increase the cost of your purchase.
Smaller Down Payment Pros
If you make a down payment
of 10% ($20,000 on the average home) or 5% ($10,000 on the average home), then
you will be able to become a homeowner faster, since you won’t have to save as
much cash. If you are able to save additional cash, it’s a smart idea to keep a
robust savings account to cover emergencies and even anticipated expenses of
homeownership such as maintenance and repairs.
There are some
disadvantages, however, to making a smaller down payment:
will need to pay PMI to your lender, which increases your monthly payments.
home loan will be larger, so your monthly payments will be larger, too.
interest rate will be a little higher, too, than for someone who makes a 20%
order to qualify for a mortgage, your maximum debt-to-income ratio must be 43%
or less, so a smaller down payment will make it harder to qualify for a loan.
The decision about the size
of your down payment depends on a variety of factors including home prices in
your market and your income. Find a good lender who will consult with you and
help you make the best choice in the context of your individual financial plan.
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