When someone says they’re saving for a house, what they actually mean is that they’re saving for a mortgage down payment. It’s unusual for anyone to show up with the full value of a property in cash, though it may be more common in today’s frantic real-estate market.
A down payment is a significant sum of money that you will put into the purchase of your new home, in which you will make monthly payments on a mortgage loan to pay off the remainder. Before you buy the property outright, it may take twenty or thirty years, or even longer.
For many people, the down payment is the most significant impediment to homeownership. Monthly mortgage payments may be the same as — or even less than — what someone would pay in house rent in the same neighborhood. However, in order to get to that point, a potential homebuyer must first have the required down payment, which may be as much as $30,000 or more in the bank.
Don’t give up! Here’s what you need to hear before making a down payment.
If you can’t afford a 20% down payment, your lender would almost certainly require you to pay Private Mortgage Insurance (PMI). This is because your bank or lender views a loan with less than a 20% down payment as a riskier loan that requires protection in the event you default on your payments.
PMIs range between 0.5 percent and 1% of the mortgage amount (annually) and these fees are included in the monthly mortgage payments. When you have 80 percent equity in your house, you can stop paying PMI.
There are definite benefits to putting down a 20% down payment, but it is by no means needed. The average down payment on a home has been between 5% and 7% in the last five years.
Keep in mind, though, that the type of loan you choose will affect how much you put down (and the length of the loan). A traditional loan, for example, requires a minimum of 3% down payment and is either 15 or 30 years long. A 3.5 percent down payment is needed for an FHA (Federal Housing Administration) loan.
A lower down payment allows you to purchase a house faster and save money for other expenses such as renovations and home improvements.
However, a lower down payment increases the monthly mortgage payments, and you’ll almost certainly need to include private mortgage insurance.
It’s simple: if you borrow less, you’ll have less debt to repay and can pay less in net interest. When the loan-to-value (LTV) ratio is lower, mortgage lenders and banks normally give better interest rates. Before approving you for a home loan, banks use your loan-to-value ratio (expressed as a percentage) to determine how risky you are.
A higher down payment also raises your home equity, which is the value of your home that you haven’t lent against and will use to refinance at a lower interest rate.
Also Read: What Is the Legal Description of Property?
Sure, you’ve been diligently saving for your down payment, but keep in mind that a bank will not grant you a mortgage until you have a certain amount of money in your bank account.
Banks and lenders would want you to be able to make your monthly payments for at least the first two to three months, often known as a cash reserve requirement. You’ll need to show that you have liquid assets in your checking or savings accounts, your bank can also accept money kept in the form of stocks, shares, 401(k)s, and other financial instruments. If your monthly mortgage payment is $2000, your lender would expect you to have at least $4000 on hand.
Bear in mind that you’ll have to make more than just your monthly mortgage payments. There are also closing expenses, such as title insurance, renters insurance, and a home inspection. Your closing costs will vary between 2% and 5% of your purchase price. So, if you purchase a house for $500,000, the closing costs could be between $10,000 and $20,000.
FYI: If you’ve been saving for a down payment but are having trouble making it happen, a down payment assistance program such as an FHA or VA loan might be able to help. These services provide support from government agencies, nonprofits, and labor unions that can be used as loans before you move in, or even as grants that you don’t have to pay back. Homeownership may seem to be out of reach financially, but it may be closer than you think.