As a first-time homebuyer, you probably have a lot of questions when it comes to buying your first house. One of the most significant elements of buying a new home is being able to put a down payment on a house. If you’re uncertain about how to obtain a down payment, don’t worry — you’ve come to the right place. Read on for your foolproof guide to putting a down payment on a house quickly.
What Is a Down Payment?
If you are looking to buy a new home, you need to understand the definition of a down payment. Essentially, a down payment on a house represents a percentage of the full price of that house. Most homebuyers acquire cash from a lender, typically a bank or other financial institution, in order to purchase a new home, but the lender won’t provide a mortgage loan for 100% of the home price.
For the lender’s security on this loan, homebuyers are required to provide the lender with a small percentage of the total loan upfront. The money you provide your lender upfront is known as a down payment. This lowers the loan-to-value (LTV) ratio of the mortgage by making the amount of the needed mortgage loan smaller compared to the home’s value.
What Is the Typical Cost of a Down Payment?
Down payment requirements vary significantly throughout the country. Factors like lender regulation and total home costs will dramatically affect the cost of your down payment. However, most homebuyers securing a conventional mortgage can expect to make down payments between 5 percent to 25 percent of the total value of their new home.
In the United States, a down payment amount of 20 percent is standard for the majority of lenders. For a $200,000 property, that comes out to $40,000. As the homebuyer, making a down payment of 20 percent on your new home is also in your best interest. It allows you to avoid paying private mortgage insurance, or PMI. It also reduces the size of your monthly mortgage payment. You aren’t necessarily required to make a 20% down payment. However, in order to offset the potential risk, mortgage lenders may require a higher credit score for you to have access to an equivalent interest rate, have you pay a higher interest rate, or require PMI.
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Lenders consider different personal finance factors, such as your use of credit cards, your job history, and your total assets. Even the housing market can have an effect on your lender’s response. Having high credit scores and other good financial markers can help reduce the impact a small down payment has on your interest rate.
What Is Private Mortgage Insurance?
If you are planning on purchasing your new home by putting less than 20 percent down, be prepared to deal with private mortgage insurance. Private mortgage insurance or PMI is primarily a security blanket for your lender.
PMI is simply a type of insurance that protects a lender, should the buyer decide to default on their loan. PMI is non-refundable money with the sole purpose of protecting lenders. Homebuyers will never see any of this money again.
Having to purchase PMI is another costly expense for new homebuyers. On a typical 200,000 home loan, the PMI would cost between 0.5 percent to 1.5 percent of the loan amount annually. Using this example, a homeowner would need to prepare to pay between $1,000 to $3,000 yearly on PMI. This averages out to a monthly payment between $83 to $250.
With all these added expenses, it is almost always in the homebuyer’s best interest to put at least 20 percent down on their new home (or create a plan to remove the PMI requirement as soon as possible). Should the funds be available to do so, it is always a good idea to put a higher percentage down.
While having to purchase PMI is not ideal, PMI isn’t all bad either. Saving up to afford a 20 percent down payment can take many individuals over five years or more to reach those types of funds. For many homebuyers, PMI gives them an opportunity to get into their own home without having to have large savings immediately available.
3 Down Payment Options to Quickly Fund a Down Payment on a House
Now that you know the ends and outs of down payments, it’s time to figure out how to fund your first down payment on a house. While it is always a good idea to save 10 percent to 20 percent of your yearly income, this is not realistic for everyone. If you don’t have 20 percent of your new home’s purchase price set away in your savings account, don’t worry — there are a number of ways for you to still fund your down payment on a house.
The top three ways to fund a down payment on a house outside of your savings account are:
- Through an FHA loan option
- By dipping into an IRA or 401(k) (for first-time buyers)
- Through state or local government assistance options
Check out which option would best suit your situation below.
1. Apply for an FHA Loan
One option to fund the down payment on a house is to apply for an FHA loan to pay less upfront, which offers loans with a 3.5 percent down payment. If you don’t have a ton of cash saved up for your down payment, applying for an FHA loan is a great option. FHA loans are simply mortgage insured by the Federal Housing Administration, or FHA.
- You have more flexibility. Typically, with an FHA mortgage loan, there are fewer regulations in regards to a homebuyer’s qualifications. Even if you don’t have an excellent credit history, there is a strong chance that you could qualify for an FHA loan.
- You can have a smaller down payment. The typical FHA loan requires just 3.5 percent of the home’s purchase price. For a $200,000 property, you can get the homeownership process underway with just $7,000 as your minimum down payment.
- You will have to pay a mortgage insurance premium, which is very similar to PMI. By putting less than 20 percent of your home’s value down on your new home, you will need to pay for insurance to protect your lender.
- You will have to ensure that you are following all of the U.S. Department of Housing and Urban Development or HUD regulations. HUD has specific regulations on what types of properties can be purchased through FHA loans. They will send a HUD-approved appraiser out to make sure your property meets all requirements.
Different loan types offer different mortgage rates. Other loan program options include VA loans through Veterans Affairs for service members, USDA loans through the U.S. Department of Agriculture, or HomeReady loans through Fannie Mae. Some mortgage brokers offering conventional loans may be able to work with you on securing a fair mortgage rate with a low downpayment. So be sure to shop around or ask your real estate agent for advice. If you have an accountant, they may also be able to advise you on the right type of mortgage for your situation.
2. Consider Dipping Into an IRA
A second option to fund a down payment on a house is to withdraw funds from your traditional or Roth IRA. In most instances, you never want to touch your retirement savings until you’ve reached the age of 60. However, there are situations where you can dip into your retirement without having to pay the early withdrawal tax. First-time home buyers are granted the allowance of withdrawing up to $10,000 from the IRA without penalty. You also have the ability to borrow up to $50,000 or half the amount in your 401(k) as a down payment loan against yourself, whichever amount is less.
- You get a low-interest rate. Through this type of funding, you will generally receive a lower interest rate than you would receive from a different lender.
- Having a lower interest rate will also provide you with the ability to put more money into your savings or pay more toward your home’s equity.
- If you’ve been contributing to a Roth IRA for over 5 years, you can pull out the contributions without penalty.
- You will be penalized if you become unemployed. If you lose your job, you are required to pay the total loan at once.
- Your overall retirement savings will be less in the long run.
3. Research Government Assistance Options
A third method of funding a down payment on a house is through government assistance programs. Each state has its own set of requirements when it comes to home loan grants and mortgage programs. Do your research to discover what type of loan or grant you may be eligible for in your state.
- This allows more individuals with lower to middle-income the opportunity to become homeowners.
- There are both loan and grant options when it comes to down payment assistance programs. Some loans in these programs are forgivable. They do not require repayment as long as you adhere to and meet specific requirements.
- There are generally very strict eligibility requirements that must be maintained throughout the lifetime of the loan.
- Most government assistance options are location-specific. You will need to do quite a bit of research to see what options are available in your state or local region.
Pro Tip: Focus on Total Home Affordability
There are other home buying costs you need to prepare for, too. These include closing costs, monthly mortgage payments and insurance, and the costs of turning the house into a home. It’s important to figure the total cost into your savings strategies so you don’t put more money down on the home purchase than you comfortably can.
Have you been looking for the right way to fund your down payment on your first home? One of these three options should be able to help you reach your goal. By following the advice in this practical home buying guide, you can obtain your down payment funding and make an offer on a house in no time at all.