If you’re like most people, you’re probably not buying a home with cash. So, before you can even think about buying the house you’ve always wanted, you’ll need a mortgage.
Until you’re pre-approved, most sellers won’t even review your offers, so working with a lender is a crucial step in your path to homeownership. And of all the fees that come with buying a home, one will put a larger dent in your bank account than any others: Your down payment.
The amount you can afford to pay upfront will have an impact at virtually every stage of the homebuying process. Choosing the down payment that suits your budget could save you thousands in the long run.
So, if you’re not sure how much to put down for your home, or you just want to learn more about how your down payment will affect you as a homeowner, stay with us!
We’ll explain the ins and outs of down payments so you can make the right decision for your mortgage.
Finding the right down payment can be a balancing act.
To begin with, your down payment will determine your interest rate. If you’re able to pay more upfront, you’ll probably get a lower interest rate.
And a small difference in your mortgage interest rate goes a long way.
Let’s say you take out a $300,000, 30-year loan at a 3.5% interest rate. You’ll end up paying an extra $184,968 on top of your initial loan amount.
Now drop the interest rate by half a percentage point—at 3%, you’ll pay $126,731 in interest. That’s an extra $58,237 in your pocket.
Still, it’s not all about paying as much as possible upfront.
You’ll have to factor in closing costs (generally 2 - 5% of your loan amount), any other monthly bills you’ll have, and the cost of moving into your new home.
So, finding the down payment sweet spot will be about your specific budget, but there are some factors you can use to help make an informed decision.
When a lender is deciding how much they’ll lend to you, one of the first things they’ll look at is your Debt-to-Income ratio or DTI.
You can find your DTI by adding up all of your debts (credit cards, car payments, student loans, etc.) and dividing the total by your income before tax.
The ratio you (and your lender) will be looking for is generally 43% or less. Other lenders may ask for 36%, but 43% is more common.
If your debt-to-income ratio is higher than 43%, you’ll have to reconsider your down payment.
Lenders will be less likely to offer affordable loans because you’re seen as a risky client.
So, with a high DTI ratio, you might have to consider paying more upfront to keep your monthly payments affordable.
Like DTI, your Loan-to-Value Ratio (LTV) will be an important factor in deciding your down payment.
Essentially, the lender will use your LTV to judge how much of a risk your loan will be. The higher your ratio is, you’ll be seen as a higher risk.
Your lender will send an appraiser to decide on the value of your home in comparison to your loan amount.
So, if you take out a $220,000 loan (with a down payment of $20,000 or 20%) and your home is appraised at $250,000, your LTV would be 80%:
(200,000/250,000) x 100 = 80%
To get the lowest interest rate available, you’ll want an LTV of 80% or less, so in this case, you’re in the clear.
If your ratio is higher, you may run into some problems. Your lender will offer a higher interest rate to make sure they get their money upfront.
Plus, you’ll probably owe some extra insurance for the lender…
Private mortgage insurance (PMI) is an issue that will come up if you can’t afford a 20% down payment.
Unfortunately, PMI is just insurance for the lender that they’ll get their money back on a higher-risk loan.
It’ll cost you 0.5% - 2% of your initial loan amount, tacked onto every monthly payment you make until the LTV ratio we talked about earlier reaches 78%.
So, on a $200,000 loan with a 10% ($20,000) down payment and a 1% PMI rate, you’d pay around $150 per month and $9,010 before you reach that 78% LTV ratio.
If 20% down seems like too much for your budget, you’re not alone.
In 2020, 71% of homebuyers opted for a down payment of less than 20 percent.
Fortunately, 20% isn’t the absolute standard for down payments anymore. In fact, many lenders offer loan options with down payments of 3 - 6% or even zero down.
So, let’s return to your specific financial situation.
If your income is good but your savings aren’t where they need to be, you may want to go with a low down payment of 3 or 6 percent. Just make sure you can afford PMI for a while!
On the other hand, if your income isn’t enough but you’ve saved up some cash, you might want to pay more upfront. You’ll receive a lower interest rate and lower monthly payments.
Like we said, it’s all about where your financial situation stands currently, as well as your plans for the future.
Still, a home can be a great investment. Interest rates are low right now, and it may be a wise choice to get your foot in the door now rather than later.
Just don’t rush into it. You’ll have to consider all of your closing costs, living expenses, and your mortgage plan to make sure you’re buying a home that’s within your means.
A good rule of thumb here is the 28% rule.
Before you buy a home, make sure that your mortgage payment won’t be more than 28% of your gross (pre-tax) income.
Setting yourself up for a solid financial future starts with your down payment.
Let’s say—like most homebuyers—a 20% down payment simply isn’t reasonable for you.
So, you pay 6% down and move into the home of your dreams!
But there’s still one problem.
Your monthly payment will probably be steeper.
That’s because, in most situations, the lender only sees you as a calculated risk. They’re only looking to make their money back with thousands in interest as a bonus.
It’s important to set a long-term financial plan, but you won’t be able to predict everything life throws at you.
In the blink of an eye, expenses can and will pop up. You might owe expensive hospital bills, your car insurance might go up, or your home might need repairs or renovations.
And with your monthly payments already high, your budget could quickly become a nightmare.
Before you know it, your dream home becomes a ball and chain on your bank account.
So, why not get your mortgage payments out of the way sooner?
Well, short-term loans aren’t exactly in your lender’s best interests.
Even if you go with a 15-year loan term, the lender will stick you with a higher monthly payment that may be difficult to afford.
Your lender wants you to believe that their way is the only way.
We believe there’s a better way.
That’s why United Financial Freedom created the Money Max Account.
Forget 15 or 30 years of giving unnecessary interest payments to your lender.
The Money Max Account is designed to help you pay off your mortgage and other debts in as little as 7 - 10 years, regardless of your financial situation.
Whether your down payment was 2% or 20% percent, Money Max can help you combine and conquer your outstanding debts.
By tracking your mortgage payment, other debts, and income, Money Max gives you the opportunity to keep your cash out of the lender’s pocket.
The results are in our name…
Financial freedom for you and thousands of other homeowners.
More money for your family and the lifestyle you choose to live.
And a debt-free future in as little as 7 - 10 years, with the Money Max Account.
Ready to learn more about what Money Max can do for you? Visit our website or give us a call. United Financial Freedom representatives are standing by to answer all of your questions.