Many of us dream of homeownership. It’s up there on the bucket list with owning a car and becoming debt-free. But owning a home may seem like a faraway dream considering all the costs involved. Weighed against your monthly income, you may think it’s downright impossible.
Don’t give up hope yet. Your future home may not be so far out of reach. With some clever financial planning and maneuvering, your home-buying goals can come true.
In today’s article, we’ll tackle one of the main hurdles you’ll face—the down payment. What it is, how much you need, and how you can save for it.
I | How Much Down Payment Should I Have When Buying a House?
What is a Down Payment?
A down payment is the upfront deposit you make to a large purchase or secure a loan like a mortgage. Lenders present this down payment in percentages. For instance, if you’re seeking a $250,000 loan with a 10% down payment, you’ll have to pay $25,000 upfront to secure the loan. The lender will provide the remainder of the property’s purchase cost.
The amount you pay down represents your ownership stakes. As you make your monthly payments and clear the balance, you’ll own more of your house until you repay the total loan amount.
Not all lenders require down payments.
Some exceptions are government-backed mortgage programs like USDA loans (offered by the Department of Agriculture) and Veterans Administration (V.A.) loans. USDA and V.A. offer financing without any down payment requirements for buyers.
Assistance is available.
You can apply for government grants to help finance a home. These grants or ‘gifts’ come as down payment assistance (DPA). You won’t have to repay the money; the only hurdles you’ll face are the availability of a grant in your area and qualifying for one.
There are also first-time homebuyer programs. These programs offer various down payment assistance for low and moderate-income earners. The U.S. Department of Housing and Urban Development lists federal rental assistance, homeownership, and home-buying assistance programs available by state.
Required Mortgage Down Payment
The minimum required down payment varies depending on the type of mortgage and the lender. Your credit score and history will be crucial to your down payment rate.
Gone are the days when 20% was the set standard. Mortgage rates now start from 0% upwards, covering a wider income bracket. The extended range provides first-time homebuyers and lower-income earners opportunities to secure loans they can afford.
Conventional Mortgage Loans
Some conventional mortgage lenders with low down payments may require you to pay private mortgage insurance if you present less than 20% of the home’s purchase price upfront.
Private mortgage insurance (PMI) protects a lender’s investment if a borrower defaults. Choosing a loan that requires PMI will increase your final loan amount. You can, however, cancel your PMI once you’ve accumulated a pre-agreed amount of equity on your home. The standard amount is usually 20% of the total loan.
Lenders who don’t require PMI attach higher interest rates on their loans.
The minimum credit score requirement for a conventional loan is around 620.
FHA Mortgage
The Federal Housing Administration (FHA) offers low down payment loans. Your upfront payment and qualification depend on your credit score and credit payment history.
The minimum credit score requirements for 2022 give borrowers with credit scores of 580 or more a 3.5% down payment rate. Borrowers with credit scores between 500 and 579 pay a 10% down payment.
The FHA requires a mortgage insurance premium. Down payment assistance is available for those who meet the eligibility requirements.
Fannie Mae and Freddie Mac
Government-sponsored Fannie Mae and Freddie Mac lenders require a 3% down payment for borrowers with strong credit scores. Their programs allow borrowers to get loans with up to 97 percent loan-to-value ratios.
Borrowers with low credit scores can still qualify if they meet certain debt-to-income and loan-to-value ratio requirements.
Benefits of a Larger Mortgage Down Payment
Zero or low down payment requirements are attractive options because they speed up your home-buying process. But in choosing speed, you’re missing the advantages of a larger down payment.
A higher down payment means lower upfront and ongoing fees.
It reduces the amount of money borrowed, lowering your monthly mortgage payment. So even though 20% is not a hard requirement, it’ll help you save thousands of dollars in loan repayment if you can offer it upfront.
You’ll own more equity in your home at the start of your mortgage term.
Higher deposits lower the risk to lenders. Because of this, you can use your down payment as leverage for lower interest rates.
How to Determine Your Down Payment Amount
How much you pay for a down payment depends on the following:
- The purchase price of the house;
- The minimum payment requirements (percentage and credit score) the lender sets;
- How much you can afford without stifling your finances.
If a lender offers a 3% down payment, but you can afford 6%, choose the higher threshold. However, consider your financial goals and present debt before making this choice.
Focus on paying off smaller immediate debts like your credit card bill with the extra cash. If you haven’t already, set up an emergency fund.
The cost of owning a home goes beyond the initial purchase. Perhaps instead of paying the 6%, you can save the additional 3% for general home repairs and maintenance. Then there are the moving expenses and personalized touches you want to add or make to your new home.
Choose your next step by calculating what makes the best financial sense for you.
II | How to Save Money for a House
1. Tighten your financial belt.
You can’t avoid making financial changes when saving for a home. These changes may include eating out less, choosing cheaper alternatives to cut grocery costs, and buying Starbucks once a week instead of two.
Whatever changes you make are unique to your current lifestyle. You’ll have to make some short-term sacrifices for your long-term gains. It may feel uncomfortable, but shuffling and downsizing are necessary if you don’t have adequate cash reserves.
2. Create a budget and look for ways to save.
Budgeting is an essential part of saving money. You need to know exactly what you’re spending before you can start saving.
Write down how much you spend each month, including your bills and other expenses. Once you’ve done this, you’ll be able to see how much you’re spending on non-essential items. A budgeting app can help you automate this process.
Use the app to track your daily, weekly, and monthly spending. Group spending by categories like food, utilities, car, entertainment, special occasion, etc. Cut back on non-essential and impulse buying. Anything that doesn’t help you achieve your goals.
Put aside money for your down payment fund every month. Savings are a non-optional expense, so make sure you save as much as possible!
Read this blog post about five ways you can master your finances.
3. Set a savings goal for your down payment.
Your goal depends on what you can afford in today’s housing market. First-time buyers are always drawn into the concept of a dream house, but you can’t always afford it as your first purchase.
Sometimes you may have to start with a “starter home,” sell it, then purchase your dream house. Or you can renovate it into your dream home. There is more than one path available. Consider them and which one makes the most financial sense.
Read this first-time homebuyer’s guide for tips and tricks and how you can avoid the major pitfalls that can hinder the entire process.
Use a free mortgage calculator to help set your down payment goal.
4. Get your debt under control.
Focus on squaring up your present debt responsibilities. Your debt-to-income ratio serves as a chunk of your ratings.
Late credit card payments and other credit infractions will affect your credit score. Review your credit report for errors and improve your score for a higher chance of receiving a favorable mortgage loan.
You can purchase a house with bad credit, but you’ll face higher interest rates than home shoppers with better scores.
5. Seek other employment options to earn extra money.
Increasing your income makes saving easier, especially when you have little money left after covering bills and other essential expenses. There are three ways you can increase your cash flow.
1. Ask for a raise or promotion
If you’ve been working at a job for four years and you’ve never received a raise, it might be time to ask for one. Your years of experience and performance will come in handy for negotiations. Also, check out the average salary for someone with your level of education and job experience. You can use this information as leverage during negotiations.
Time your raise conversation right. Mentioning the topic during your performance review is a good time. Come prepared. Create a portfolio of your top achievements thus far. Show your worth and why you continue to be an asset to the company.
Approach the conversation with confidence. If you don’t have confidence in your abilities, your employer has no reason to either.
Use the same approach when applying for a promotion. Show why you’re the best person for the job. Your knowledge of the company’s culture and “knowing all the internal corners” can give you a leg-up over an outside applicant.
2. Find a new job
Choosing when to move on from your current job can be emotional. It may also cause anxiety when you consider the craziness of the job market.
Job hunting takes time. But landing one with a higher-paying salary will give your savings a boost. As you improve your skills at your current job, keep an eye out for better-paying positions you qualify for.
3. Starting a side hustle
It’s easier than ever to earn extra cash with a side hustle. Look at your skill set and determine what skill or skills in your arsenal can become a lucrative venture. As a freelancer, you can work with clients outside your regular 9-5, completing gigs on a contractual basis.
6. Track your progress.
Open a dedicated bank account for your down payment. Keeping your money separate makes it easier to track your savings progress. It will also prevent you from dipping into the reserved cash by accident.
Funnel excess funds like gift money, tax refund, and other windfalls into your house fund. Keep an electronic or physical record of your ‘sinking fund’ updating the goal amount, deposits, and outstanding or accumulating balance.
Conclusion
Saving for your down payment (if you need one) is a critical step in buying your dream home.
Review all available loan types and the qualifying criteria ahead of time. Once you know what you need, you can set yourself up for success.
- Tighten your financial belt and access your spending habits.
- Build a budget and look for ways you can save by cutting down on non-essential and impulse spending.
- Set a savings goal for your down payment. Using a mortgage calculator can help you with calculating an estimate.
- Get your debt under control and improve your credit score for favorable rates and terms.
- Seek other employment options to earn extra money and make saving easier.
- Track your progress and keep your goal of owning your own home at the front of your mind.
