How to Choose a Down Payment
When it comes to home buying, the down payment is often the foundation for every other financial decision that comes next. Typically, the more equity homeowners have in the home, the lower their interest rates and monthly payments. However, the down payment is just one cost of many when it comes to homeownership, and it is easy for buyers to opt for the bare minimums. Learning about the many options available can be the key to determining just how much money a down payment will cost.
The Ideal Scenario
No matter what type of loan a homeowner takes out, the goal is often at least 20% of the purchase price. This establishes a strong amount of equity in the home immediately and may even result in monthly payments being easier to handle. For most types of loans, this amount will eliminate the need to pay for private mortgage insurance (PMI.)
PMI may add as much as an additional $100 to every monthly payment for a $100,000 home until the homeowner officially reaches 20% equity. Once they hit the required amount of equity in their home, homeowners are deemed less likely to default on their loan. Of course, as home prices rise and personal savings accounts dwindle, about 55% of all buyers can't come up with the requisite 20% down payment. That's why it helps to know the different choices for down payments to get the best deal.
Types of Loans
The most common mortgages all have their own terms when it comes to the minimum down payment. An FHA loan has a minimum of 3.5% while a conventional loan can be secured with as little 3%. Those who take out a VA loan or a USDA loan are not typically required to put down a down payment of any kind. These types of loans are both secured by the government, so PMI is not required.
Instead, VA applicants will pay Funding Fees to the VA department, with the total fee partially dependent on the amount of the down payment (e.g., the higher the down payment, the lower the Funding Fee.) For USDA loans, those who can't put down 20% will pay an upfront cost equal to 2% of the purchase price to cover the chance of default. (The 2% charge is far less than standard PMI will cost.)
How to Decide
Lenders are usually the key to answering the question of which down payment is best. One lender may have very different minimums and policies for a home loan than another, even though each offers the same type of loan. For those who are able to get a loan secured by the government, they will need to meet a number of criteria including minimum credit scores, location requirements, and average home prices.
For example, VA loans have a cap on the secured amount a buyer is allowed to take out in different cities. Therefore, a person living in New York City has a maximum of $679,650 while a person living in Salt Lake City can take out up to $600,300. Those opting for USDA loans are typically required to live in more rural areas in order to qualify. Lenders may add their own spin on the process (e.g., higher credit scores, etc.) when it comes to which applicants they accept or reject.
Mortgages are structured upon down payments because the policies save lenders from having to spread the risks out to other home buyers. So a Hernando homeowner who puts down 3% on their home and then defaults after a year is covered because they already paid the insurance on their mortgage. Because the homeowner took on the individual risk, interest rates don't have to climb for those who are able to put down 20%. Buyers should do their research when it comes to their lender's rates, reputation, and requirements.
Choosing how much to put down is highly dependent on the type of loan and lender a buyer chooses. However, all homebuyers should be trying to establish as much equity as possible from the moment they find their dream home. Doing so will ultimately save more money over time while also building up the homeowner's credit score and financial portfolio.