When determining how much to save for a down payment, setting aside as close to 20% of the home’s purchase price as possible is ideal. This allows for less interest and fees, and more equity in the home right off the bat.
But many homebuyers, especially first-time buyers, make down payments of less than 20%. This is more common and prevalent in high cost housing areas, such as California.
While down payment obligations vary from lender to lender, and primarily depend on credit health and debt-to-income ratio, most traditional loans only require a minimum of 5% down. The average down payment on a U.S. home is 10%. However, some loans (such as FHA and Conventional) require as little as 3 – 3.5% down payment.
How to determine how much to save for a down payment depends largely upon the lender’s requirements, the borrower’s personal financial standing and whether they qualify for certain homebuyer programs.
A good rule of thumb is to save an additional 3 – 6% of the loan balance to cover closing costs, unless seller concessions can be negotiated or some of the fees can be wrapped into the loan. It is also smart to save three months’ worth of living expenses so there aren’t any stressors in the event of an emergency.
Benefits of a higher home down payment:
- A cleaner path to loan approval; increased chances of mortgage approval with a bigger down payment, as lenders will likely view you as a good saver, and thus a lower credit risk.
- Lower mortgage rates: Since a higher down payment reduces your loan-to-value ratio, or the loan amount compared with the home’s value, you can usually get lower interest rates from lenders. Any hike in the amount of a home down payment lowers loan-to-value ratio while also reducing risk to the lender.
- You’ll likely pay off your mortgage sooner: The more cash you can put down, the lower your loan amount. That makes it more likely you can pay off your entire mortgage sooner, saving you interest and letting you build equity more quickly.
- A lower monthly mortgage payment: A larger home down payment cuts your monthly mortgage bill, leaving you with extra cash for other financial considerations, like college or retirement savings.
- No mortgage insurance: By steering more cash into a home down payment, you can avoid paying private mortgage insurance (PMI). When you put less than 20% down, your lender will likely require you to pay PMI, which it may charge as an upfront fee or as part of your monthly payment. This protects the lender if you can’t pay your mortgage.
When considering the minimum down payment you’re willing to make, think through whether putting less down is a reflection of your readiness to buy a home. While it’s possible to obtain a loan with a small down payment, it’s important to have savings on hand before purchasing a home and ample income to pay the mortgage as well as the other costs that come with owning a home.
Using money from retirement savings or an emergency fund for a down payment/ongoing expenses is a sign you should spend more time saving to prepare yourself for buying and owning a home.
If you are looking into your first purchase and have some questions about how much to save, give us a call at (760) 930-0569 and one of our loan officers will assist you.