How Much Downpayment Is Needed To Buy A House?

How Much Downpayment Is Needed To Buy A House
by Kevyn Pitts - August 31, 2022,

The down payment is one of the largest up-front costs when purchasing a property. Not to be confused with closing charges, the down payment is the upfront portion of the purchase price. If you put less money down on a property at closing, you will typically pay more in fees and interest over the life of the loan (and vice versa).

Key Points

  • The down payment you make on a home affects the type of mortgage for which you qualify, the amount of money a lender will grant you, and the terms and conditions of the loan.
  • But the size of your down payment also affects your lifestyle and long-term financial planning objectives, as it dictates your monthly mortgage payments and the amount of money you'll have for other obligations.
  • Keep in mind, if you've only ever rented, that your monthly expenses as a homeowner will include more than just the mortgage: property taxes, maintenance, insurance, and possible repairs.
  • With a greater down payment, the loan-to-value ratio, or LTV, will be reduced. This essential step makes you less hazardous to lenders, which may qualify you for lower interest rates and help you avoid expenses like private mortgage insurance.
  • Bigger down payment may make you more competitive as a buyer since you will be perceived as more dependable, less likely to negotiate, and less likely to request that sellers cover closing expenses.

Loan-to-Value Ratio and Down Payment

Your down payment has a significant impact on your loan-to-value ratio (LTV). To obtain the LTV ratio, the loan amount is divided by the property's estimated fair market value, as determined by an appraisal. The more your down payment, the less your LTV will be (and vice versa). Since lenders use LTV to evaluate borrower risk and price mortgages, a lower LTV implies you pay cheaper mortgage interest rates and may avoid additional fees.

A lower LTV ratio exposes lenders to less risk. Why? You have more equity in your home to begin with, which indicates that you have a larger investment in your property relative to the outstanding loan balance. Lenders estimate you will have a lower likelihood of mortgage default. If you default on your mortgage and the lender must foreclose, they are more likely to resell the property and recover the majority of the loan value if the LTV ratio is lower.

Lenders utilize the LTV ratio to price your mortgage, in addition to evaluating your risk. A lower LTV ratio will usually result in a lower interest rate. Expect higher loan rates if the LTV ratio reaches 80%, implying you've placed less than 20% of the home's value down. These rates reflect the additional risk associated with lending you money.

In addition, if your LTV ratio surpasses 80%, you will likely be required to pay for private mortgage insurance (PMI). The amount of PMI you must pay depends on the type of loan you have. Some FHA-insured loans, for example, demand both an upfront mortgage insurance payment paid at closing and an annual mortgage insurance premium (MIP) for the life of the loan. Although FHA loans need a low 3.5% down payment, the total cost of borrowing, as estimated by the annual percentage rate, is typically substantially higher for these loans.

Programs For Low Down Payment Loans

Historically, homebuyers needed a 20% down payment to purchase a property. The times have evolved. Many homebuyers, especially first-time homeowners, lack the 20% down payment required by most lenders. As home prices climb in a number of U.S. housing markets, this is increasingly the case. According to the most recent data from the National Association of Realtors, the median price of an existing home in October 2021 was $353,900, an increase of 13.1% from October 2020s, $313,000.

According to the NAR's 2021 Home Buyers and Sellers Generational Trends Report, purchasers who financed their purchase paid down an average of 12% of the purchase price.

Several types of mortgages offer a low down payment alternative for consumers who cannot afford a 20% down payment.

Four Ways To Increase Your Down Payment Savings

It can be difficult to save enough money for a home's down payment. Here are a few tips to help you get there:

  1. Start early with a plan that is automated. In addition to your usual savings account or emergency fund, you should open a savings account specifically for your down payment. After each pay period or windfall (such as a financial gift, tax refund, bonus, or inheritance), put funds into a down payment savings account and observe the balance rise over time. Contributing as early and frequently as possible to this money can help you stay on track.
  1. Reduce your expenditures. If homeownership is important to you, you should eliminate or reduce non-essential expenses such as cable and TV service, eating out, vacations, and others. By spending less, you will be able to save more for your down payment and pay off other bills. To achieve your homeownership objectives, making sacrifices today might go a long way.
  1. Pay off loans with hefty interest. High-interest credit cards and loans can harm your credit score and are costly in the long term. Concentrate on paying off these accounts first, and you'll experience a snowball effect in your debt reduction. Once you've paid off these accounts, you can then apply the monthly payments to your down payment savings. However, you should not close these accounts, as doing so will damage your credit score by removing an open credit line and account history. Instead, use them sparingly (gas or an occasional restaurant meal) and pay off the balances immediately. This conduct strengthens your payment history and demonstrates appropriate credit utilization to credit bureaus and lenders.
  1. Get another job. Many first-time buyers discover that by increasing their income, they can save far more quickly. Finding side jobs you can do from home or seasonal retail work can help you save for a down payment. Even if you work briefly for six months or a year before purchasing a home, the additional income may be sufficient for a substantial down payment.

Example Of a Down Payment

The logistics of making a down payment are rather simple. Imagine that you have an accepted offer to purchase a property for $500,000 with a 20% down payment. The amount of the down payment would be $100,000 = (500,000 x 0.20). This amount must be deposited promptly into an escrow account, which will be maintained until closing. It will be applied toward the total amount owed at closing.

You should read our article to determine the income that you need in order to buy a house.

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