The Down Payment Dilemma
There are several very good reasons to save for a large down payment before you buy a home, but when rates and prices are going up, many prospective buyers worry that taking any more time to save will cost them more than a large down payment is worth. There are indeed many ways to get a mortgage with relatively little cash up front, and making this choice often comes down to how much personal debt you have and whether saving a little more can get you out of paying mortgage insurance.
The Benefits of a Large Down Payment
Traditionally, the ideal down payment for a home is equal to 20 percent of the purchase price. For a $250,000 home, this would be $50,000, which is rather more than the average American has set aside in the ol’ piggy bank these days.
The advantages of putting 20 percent down, however, should not be ignored:
- It’ll be much easier to qualify for a home loan.
- You’ll have a lower monthly payment.
- You’ll save enormously on interest in the long run.
- You’ll have substantial equity built up in your home from the moment you move in.
The most important point to make is that with a 20 percent down payment, you won’t have to pay extra every month for mortgage insurance. Mortgage insurance, whether it’s a private mortgage insurance policy or the mortgage insurance premium for an FHA loan, costs you thousands of dollars extra over the life of your loan, with no benefit to your home equity.
Low (and No) Down Payment Options
The government-sponsored enterprises that back up most of the mortgage industry recognize that saving tens of thousands of dollars for a home purchase is very challenging in our modern economy. In addition, various government departments have been increasing access to mortgages for decades.
- It is now possible to get a conventional mortgage with as little as 3 percent down if you have great credit and plenty of income.
- The Federal Housing Administration (FHA) makes it possible to get a mortgage with a down payment of 3.5 percent even with less-than-perfect credit.
- The Department of Agriculture (USDA) has a zero-down-payment program for people buying homes in certain rural and suburban areas.
- The Department of Veterans Affairs (VA) famously grants service members, veterans and eligible spouses the benefit of being able to qualify for a mortgage with no down payment.
- Many state and local governments offer down-payment assistance grants and no-interest loans to encourage homeownership in select communities.
If you’re able to take advantage of one of these options, and it looks like home prices may rise faster than you can save more money, then seizing the moment may well be the wisest course of action.
Two Special Considerations
Ultimately, you have to use your best judgement to decide whether to buy with a low down payment or put more of your own savings into the home up front. That said, there are two situations in which a clear-cut case can be made:
- High Personal Debt: If you have to make hefty payments every month toward credit card balances or other high-interest debts, you should pay down this debt as much as reasonably possible before applying for a mortgage — even if that means using part of your down payment savings to do it. Debts in general make it more difficult to qualify for a home loan, and mortgage interest is usually easier to live with than the interest that accrues on credit card balances.
- Avoiding Mortgage Insurance: If you are not eligible for a VA loan, and you already have enough saved to put 15 percent or more down for your target home price, you should seriously consider either saving more money or looking for a less expensive home in order to get your down payment up to 20 percent. Doing this will take mortgage insurance completely out of the equation, which will save you thousands upon thousands of dollars in the long run.
Buying a home conventionally with 4.5% interest rate
Home Price: $250,000
Loan Amount: $200,000
Term: 30 years
Buying a home FHA-style with 4.25% interest rate
Home Price: $250,000
Loan Amount: $241,250
Term: 30 years
(Interest + Mortgage Insurance)$186,001 + $65,309
*These figures are given for example purposes only. The interest rates shown were par rates as of April 12, 2017, but rates are subject to change on a daily basis. Contact a loan originator for a current estimate.