Q: I'm hoping to buy a house in the next few months. How much of a down payment should I have saved up?
A: When you think about your down payment, balance is key. If you think you might sell the house within just a few years of ownership, having a large down payment exposes you to greater risk if real estate prices fall. However, a larger down payment can also mean lower monthly payments.
The value of $1,000 is pretty hard to quantify, especially in a real estate market that might have $30,000 homes and $300,000 homes. Instead of thinking about the amount of money, think about a percentage of the value of the house. When making these decisions, here are three questions to ask yourself.
Can I put 20% down?
A down payment of 20% is something of a magic number. With 20% down, borrowers are no longer responsible for carrying Private Mortgage Insurance (PMI). PMI is a protection most lenders require to cover their investment in you should you not repay your loan. The premiums for this insurance are paid by you, either as a lump sum at closing or included with the mortgage payment, and thus make your monthly payment higher. PMI usually costs between 0.5% and 1.0% of the value of the loan, though prices vary based upon several factors. Using this model, on a $100,000 loan, expect to pay around $83 more per month.
20% is also a magic number for interest rates. Lenders see a 20% down payment as a sign of a responsible borrower. Meeting that down payment amount means the borrower typically has a lifestyle of spending responsibly and saving money, both of which are signs of a solid credit risk. Regardless of your credit score, a 20% down payment can help save on the costs of the loan.
Can I get help to get there?
There are a wide variety of home buyer assistance programs designed to help people reach that 20% threshold. These come in two forms: grants and delayed repayment loans. They're offered by housing departments at all levels of government and frequently go unused because home buyers don't think they qualify.
Grants are no-strings-attached checks that you have to use for a specific purpose, in this case, the down payment on a home. Many are limited by income level or region of purchase, but they are definitely worth exploring. Even more options are open to first-time home buyers, former or current members of the armed forces and people in public service-oriented professions.
Delayed repayment loans are similar. These are second mortgages held by an organization for a portion of the total cost of the house. They do not begin accruing interest until after you've paid off your primary mortgage, and some of them are forgiven after you've owned the home for a certain amount of time. These are available from housing authorities and private organizations all over the country.
One important note: While you can get a lot of help, you cannot use another loan, even one from your parents or relatives, as part of your down payment. Doing so is a federal crime and can get you in serious trouble! In the best case, lenders will be suspicious of large deposits you can't explain, and may even refuse to issue the mortgage loan.
If you can't get to a 20% down payment, there are several options. You could make the smaller down payment, understanding that you'll have to pay higher interest rates and PMI. You could also look at houses in lower price ranges. You might also decide to postpone home ownership and focus on saving so you can get there the next time around.
Should I go over 20%?
Making a very large down payment is an investment. Think of your mortgage like a savings account. You make an initial "deposit" when you make a down payment. A portion of your payment goes into your account each month while the rest goes to cover interest, which is the price you pay for living in your savings account. The return on your investment in the large initial down payment is the lower total interest you'll have to pay.
When deciding if you want to put more than 20% down, think of your mortgage rate like the rate of return. If you can put another $1,000 down, that's $1,000 less you'll need to borrow. If your interest rate is 4%, then the return on that investment is $40 in interest you don't have to pay. On the other hand, you don't have that $1,000 to invest somewhere else now. If your retirement account earns 5%, then that same $1,000 will earn $50 if invested there. Making the larger down payment will end up "costing" you $10 in the long run.
As with any other investment decision, weigh the pros and cons. It may have a comparatively low rate of return, but the risk is negligible. Unless the value of your house drops dramatically, you won't lose your down payment. It can be a smart move to put down as much as you can, but make sure to leave your retirement fund and emergency fund intact.