When you’re trying to purchase your first home, saving up for a down payment can be a long, difficult process. And it can be confusing; while one financial expert may recommend a certain percentage amount, another expert might disagree.
Due to different types of mortgages and different financial strategies for buying a home, it can be tough to pin down the right amount of down payment needed before you can start crashing open houses in search of your first home.
The size of your down payment will be affected by your target price range for a home, the type of loan you take out, and your own comfort regarding the size of your mortgage payment. If you’re still in the process of saving, here’s an overview of how much you’ll need to buy a home.
The Ideal: 20 Percent Down Payment
In a perfect world, homeowners are able to put down 20 percent as a down payment. This is the amount preferred by lenders because it gives them leverage if you can’t pay your mortgage. If your house goes into foreclosure, the bank can repossess your home and sell it, even at a loss, and still recover their debt.
A 20 percent down payment also saves you from having to purchase an insurance policy to protect the bank in the event of a foreclosure. If you have the financial means, it’s a good practice to aim for this amount while building up your savings.
Remember that a down payment is proportionate to the cost of a home. If you’re looking at homes between $200,000-$300,000 in value, a 20 percent down payment can range from $40,000-$60,000. If you’re committed to putting down 20 percent, your down payment funds will determine the maximum amount you’re able to spend.
The Exception: FHA and Military Loans
Conventional mortgages are fairly standard in terms of the rates they offer as well as the terms and conditions of the loans. But certain types of mortgages cater to specific consumers in unique circumstances, and it may be worth considering these alternatives.
A Federal Housing Administration (FHA) loan, for example, is a loan product that tends to be popular with first-time home buyers due to the lower income limits and other requirements of this type of mortgage. These loans, which are insured by the FHA, provide low- to moderate-income borrowers with loans that make home ownership more accessible—even if you have less-than-perfect credit. These loans also offer a minimum down payment as low as 3.5 percent of the value of the home.
If you’re a military veteran, you may qualify for special VA loans that can offer exclusive rates and terms on mortgages, including mortgage products that require no down payment whatsoever.
The Catch: Paying for Private Mortgage Insurance
Though you can purchase a home with a conventional loan with less than 20 percent for the down payment, you’ll need to factor in the added cost of private mortgage insurance (PMI).
PMI is a safeguard used to protect lenders in the event you can’t pay your mortgage. Instead of using the down payment as leverage, homeowners purchase an insurance policy that will compensate the bank if you foreclose on your loan.
PMI is added to your mortgage until your equity in your home surpasses 20 percent, at which point you can have the insurance removed. This is achieved by making regular monthly payments, making improvements to the home, and/or experiencing an increase in your home’s assessed value.
Although PMI is a sunk cost for homeowners, it provides an option for purchasing a home—and taking advantage of a buyer-friendly market—if you don’t have enough saved for a full 20 percent down payment.
The closer you’re able to come to a 20 percent down payment, the better your mortgage repayment options will be. But if you can’t hit that mark, there’s no need to worry—between alternative mortgage options and PMI, many lenders offer flexibility to help you finance your home purchase.
The most important step is making sure you choose a home that fits your family’s needs and your personal preferences. You can learn more about the ins and outs of home-buying by checking out The Essential Guide for First-Time Home Buyers.