When buying a home, most people take on a mortgage. There are many things to consider when taking on a mortgage loan, including interest rate, closing costs and the down payment. Once you calculate how much house you can realistically afford, you can start looking at properties and considering how you will afford the house.
There are several ways to fund what will likely be the biggest purchase of your life. Before you start signing with lenders and sellers, it's a good idea to consider how much down payment you should be making and how that will affect you both immediately and in the long run.
In case you are really new to this, a down payment is the chunk of cash you pay upfront when buying a home. This money shows the lender that you are capable of saving and are so serious about this investment that you are willing to put that savings toward making the home yours.
The Magic Number
You may hear that the typical down payment amount is around 20% of the total property value. While some people (like veterans) can qualify for homebuying assistance, most people will have to put 20% down to secure their mortgage without paying private mortgage insurance or taking out a second loan. When you are thinking about what type of house you want and what exactly you can afford, it's important to keep in mind you will likely want to have 20% of the property's value in savings dedicated for just this purpose before purchasing a home.
If you have more than 20% of the home price socked away in savings, there are some reasons for using it as a down payment. The more you put down, the better position you are in for negotiating a lower interest rate with your lender. You will also have to borrow less if you put more down, meaning you will pay less in interest payments over the life of your mortgage.
Before you jump into this option though, it's a good idea to be sure you can comfortably afford this house without putting your regular costs at risk, consider what other debts you may have and whether you think the savings could do more for you if used elsewhere. For example, it's important to maintain an emergency fund so that you have cash set aside if (and when) the unexpected happens.
While the financial crisis left many homeowners defaulting on their little-to-no-money-down mortgages, the tide has turned again, and now the minimum amount needed for a mortgage is only 3.5% (there are some zero-down mortgage programs, but certain restrictions apply). In order to pay less than the normal 20%, you have several options.
You can secure a second loan to make up the difference between what you can afford and the 20% mark. You can also take out private mortgage insurance (PMI) to give your lender peace of mind. In case you get into trouble making payments down the line, this policy would pay the lender. You can check if you qualify for a loan backed by the Federal Housing Administration (FHA). You can also look for state and region-specific down payment assistant opportunities through your local government. If you are buying a house with less than the typical down payment needed, it's important to know that you are taking on more risk.
Before you apply for a home loan, it's important to know where your credit score stands. The difference of just a few credit score points can mean better interest rates and a major savings over the life of your loan. You can get two of your credit scores for free on Credit.com, updated every month.
Your down payment amount makes a big difference both now and down the road, but it's a good idea to leave yourself enough money to afford your next few monthly payments as well as closing costs and other immediate expenses the house may incur. Remember, this is just the beginning.
More from Credit.com