There once was a time when homebuyers had limited choices in their down payment amount. With a few exceptions, if you wanted to buy a home, you had to save up 20 percent of the purchase price. Since the average home price in the United States is $200,000, this would mean saving up $40,000 before buying. Today, buyers have more options to get into a new home, but not all options are good choices for everyone.
Home Purchase Financing
Down payment rules are dictated by lending guidelines. The more you put down, the more secure a lender is in the event you don’t make your payments. Some loan programs allow smaller down payments. You can put 10 percent, 5 percent and in some cases, even less.
Higher Down Payment Equals Lower Costs
Lower down payments come with a catch, though. The banks still need security in the event of your default, so when you put less than 20 percent down, they will require you to purchase private mortgage insurance or PMI.
PMI adds to your monthly mortgage payment. The amount varies, but averages between .5 and 1 percent of your mortgage balance. In a $200,000 mortgage, this could add between $100 and $200 to your monthly bill. Even with the higher payment, a smaller amount down may make sense.
What’s Your Debt Situation?
If the 20 percent down payment is the entire amount of your savings and you also are carrying high credit card debt, you may want to steer that savings toward paying down those cards instead of building immediate home equity.
It’s also essential for homeowners to build a reserve fund for emergencies, about three month’s worth. If fully funding a 20 percent down payment leaves you with zero in the bank, don’t dump all your cash into the house. Pay down debt, set aside some reserves and take advantage of the PMI availability.
As you pay your mortgage balance down, you will build equity and be able to remove the PMI requirement after a period. When buying a new home, think about your overall financial picture after purchase, and plan for comfort and savings in the future.