Buy Side | How Much Do You Need for a Down Payment on a House? – The Wall Street Journal
Sometimes the thing standing between you and the keys to your dream home is a down payment. With a down payment, you give the lender a certain percentage of the purchase price of a home up front, and then you borrow the rest.
A down payment is the big kahuna in the homebuying process. For one thing, it says you’ve come to play and now officially have skin in the game. Your down payment affects your total monthly payments. It significantly reduces the overall cost of buying a home since it reduces the principal on which you’ll pay interest. The larger the down payment the less risk there is for the lender and the more likely you are to be approved for a loan and get a lower interest rate.
No doubt you have questions. We’ll tell you how much is required to put down on a house and how much you should put down. You’re likely wondering what you have to lose and gain if you go above and beyond the requirements and just what is this Private Mortgage Insurance that you keep hearing about. Relax, we got you.
You probably have 20% stuck in your head as the required amount to put down on a house. That’s not always the case. What’s needed depends on the type of loan you have and the lender. But the 20% figure is important because if you put down less than 20%, for most mortgages, you’ll be required to have private mortgage insurance orPMI.
According to 2021 research from the National Association of Realtors, the
typical down payment for first time home buyers was 7% and 17% for repeat buyers. The average sale price of a house in the U.S. during the second quarter of this year was $525,000, so that would have resulted in a down payment of $36,750 and $89,250 respectively. Talk to a lender about what’s required to get the best deal on a mortgage.
Know that while what’s required for a down payment varies by lender, there are a few factors that typically come into play and help determine how much you’ll need for a down payment. Take for example three of them.
Credit score: Your credit score will affect what interest rate you qualify for. The higher your credit score, the lower your interest rate and the monthly payment will be. “If you’re buying in a hot housing market, you may need to make a larger down payment in order to compete with other buyers who are also trying to purchase the same property,” says Jenna Lofton, a certified financial advisor in New York city, and founder of investing and finaStockHitter.com.
Income: Higher income allows for larger loan amounts and lower debt-to-income ratios, another factor lenders consider when approving a loan.
Interest rate: The lower your interest rate, the lower your monthly payment will be.
Lofton says the credit score is critical. She offers an example. Let’s say you’re buying a $100,000 house and you have a credit score of 720 and make $50,000 a year, you may be able to get approved for a loan for the full purchase price. However, if your credit score is 620 and you make $100,000 it’s possible that you might only be approved for a loan of $80,000, meaning you’d need to fork over $20,000 as a down payment. The difference is because with a higher credit score you are seen as less of a risk to the lender.
If you have a conventional mortgage and put down less than 20%, you will have to pay PMI, most often in the form of a monthly premium that is paid when you make your regular mortgage payments. Its twin of sorts, MIP, or Mortgage Insurance Premium, is applied when putting down less than 20% and using an FHA loan.
These figures are often expressed by the term loan-to-value ratio, or LTV. If you put 20% down, your LTV will be 80% when you purchase the house—but if you are lucky it will grow over time as the value of your home increases.
So why the magical 20%? It’s generally what the mortgage industry considers a reasonable amount to cover the lender’s costs if you default on your mortgage. You can apply to cancel private mortgage insurance once you reach 20% equity in your home. Good news indeed, since for a conventional loan, the average cost of PMI starts around 0.5% to nearly 2% of the original loan amount per year.
For a conventional loan (any mortgage loan that is not insured or guaranteed by the government), anticipate a minimum of 5% of the home’s purchase price, though there may be special programs for first-time homebuyers at a 3% rate.
FHA loans are insured by the U.S. Federal Housing Administration and issued by a bank or other approved lender and require a 3.5% down payment of the home’s purchase price.
Through a program established by the U.S. Department of Veterans Affairs, active service members, veterans and their surviving spouses can get loans at 0% down and no PMI.
Eligible borrowers can get zero-down mortgages. You can find out whether you’re likely eligible on the USDA’s website. Lenders may have their own guidelines, but at a minimum the USDA requires you be purchasing in a qualified rural area, be a U.S. citizen or legal permanent resident, able to prove creditworthiness, typically have a credit score of at least 640, stable and dependable income, generally 12 months of no late payments, an adjusted income equal to or less than 115% of the area median income and the property serves as the primary residence.
Expect to pay a higher down payment and that the lender will be looking for stellar credit scores too. Why? If things go south for you, lenders believe you’re more likely to stop paying the mortgage on a second home or rental property than your primary residence. They want to cover themselves. For rental properties and second homes, the minimum is at least 10% and often 20% to 25%.
“In Florida, second homes or Airbnb-style rental properties that are not a borrower’s primary home typically require 50% down or more, because the risk of any borrower with two homes increases dramatically,” says Baron Christopher Hanson, a realtor with Coldwell Banker in Stuart, Florida “Defaults and foreclosures in Florida on second and third homes is one of the largest sources of new inventory.”.
If you’re a first-time home buyer, you may not be in a financial position to put down more than the minimum. But what if you have the luxury of doing more than required, is it worth it? Afterall, not having to pay PMI is a savings. The more you put down, the less you borrow. This can mean big savings in interest, and you’ll build equity faster. A hefty down payment might get you a better interest rate too on top of lower monthly payments.
However, “I’d rather put down 10% and have plenty of cash available for planned and unplanned expenses, than put down 20% and be stretched, even if that means paying a bit more in PMI,” says
Scott Trench, CEO and president of BiggerPockets.com, a wealth building and real estate investing community, and author of “First Time Home Buyer.”
You also might want to make a smaller down payment and use what you would have put down toward investments. Consider too, the price of waiting until you have a 20% down payment. Home prices and interest rates could rise.
“There are a lot of factors to evaluate; blanket advice doesn’t work,” Hanson says “It comes down to what your personal situation is, what works for you.”
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