The amount of a down payment you’ll need will depend on what kind of mortgage financing you choose, but most of the times you’ll need at least a minimum of 3% to 5% of the purchase price plus some additional cash to cover closing costs. If you’re in active military duty, a veteran, or in the reserves, you may not need a down payment at all.
Minimum Down Payments
The most common types of financing in today’s mortgage industry are conventional, FHA financing, and VA financing. The following is a rundown of the minimum down payments required for each type of financing:
- Conventional: If you have really good credit, you can buy with as little as 3% down, but you’ll likely get a much better deal by coming in with at least 5%. For loan amounts greater than $417,000, you may need at least 10% of the purchase price. Don’t forget that mortgage insurance (MI) is required if you bring in less than 20% of the purchase price, but you can get the MI dropped once you’ve paid down the loan to 80% loan-to-value (LTV) or lower.
- FHA: FHA financing requires at least 3.5% down, but regardless of the down payment, you’ll be required to carry mortgage insurance. And unlike conventional financing, you won’t be able to get it dropped when the loan is paid down to 80% LTV. Under the latest FHA guidelines, if you put down 10% or more you’ll have mortgage insurance for at least the first 11 years of the loan. If you put down less than 10%, you’ll be required to carry the mortgage insurance for the life of the loan.
- VA: A VA purchase loan is probably one of the best mortgage deals available, but you have to be military active duty, a veteran, or in the reserves. If you’re eligible, you can buy a home with 0% down and no mortgage insurance (yes, you read that right!).
Though the guidelines may allow for a minimal down payment, it’s a good idea to pay a larger down if you can. The following are a few reasons to keep in mind:
- Lower mortgage payment. If you put down more, you’re borrowing less, which means your mortgage payment will be lower. This gives you more monthly cash flow and will make it easier to handle unexpected expenses or a loss of income.
- More equity. If you have a larger down payment, you’ll have more equity right away. This takes away some of the risk of being upside down in the mortgage if home values fall in the future.
- Lower rate and/or closing costs. With more equity, it’s a less risky loan for the lender, which means you’ll likely get a better deal.
- You’re more likely to get your offer accepted. For many of the reasons already mentioned, having a larger down payment means your offer is stronger because your financing is more likely to be approved.
- Opportunity for a shorter loan term. If you’re borrowing less, you may be able to more easily manage the payment of a shorter loan term. Shorter loan terms pay off faster, build equity quicker, and often come with lower rates. Plus, they can save you an enormous amount of interest over the life of the loan.
Even if you can’t put down enough to avoid mortgage insurance, it still could be worth it to put down more than just the minimum required by the lending guidelines:
- Lower mortgage insurance premiums. Whether you’re taking a conventional or FHA loan, mortgage insurance premiums are calculated based on loan amount. If you have a larger down payment, the loan amount will be lower, which makes your mortgage insurance premiums lower as well. In the case of conventional financing, mortgage insurance premiums are also tied to LTV. Putting down 5% instead of just 3% can result in a significant reduction in the mortgage insurance premiums you pay. The mortgage insurance premiums get lower with each 5% reduction in LTV until you reach 80% LTV, where the premiums go away altogether. For example, conventional mortgage insurance premiums are lower if the LTV is 90% instead of 95%. The same applies if the LTV is 85% versus 90%; you’ll get a lower mortgage insurance premium to reflect the reduced risk for the lender because you’re bringing more equity to the deal.
- Get rid of mortgage insurance sooner (conventional financing): If you’re stuck with mortgage insurance, making a larger down payment means you’ll pay down the loan to 80% LTV sooner and be able to drop the mortgage insurance (assuming you take out a conventional loan).
Lenders like it when you bring more of a down to the deal because you have more equity in the deal right off the bat, which equals less risk for the bank. And if there’s less risk for the bank, you’ll likely get a better deal.
You’ll Need to Cover Closing Costs Too
Don’t forget that the down payment isn’t the only thing you’ll need to pay for at closing. You need to plan to have an additional 2% to 4% of the purchase price on hand to cover closing costs. This doesn’t mean you’ll actually need to spend that much, but it’s better to have more money on hand than not enough.
Closing costs can vary quite a bit depending on the financing you select and where you’re buying a home. Be sure to work closely with a good real estate agent and loan officer for estimates most applicable to your situation.
Using Gift Funds
Another great way to raise cash for a down payment is through gift funds. If it’s a possibility you might go this route, be sure to work closely with your loan officer on the proper way to handle and document the gift funds. Lending guidelines can be very strict regarding gift funds, so it’s important to handle them correctly so you don’t create any headaches for yourself (or get your loan turned down).
How Much Money Will I Need?
To get a feel for how much money you’ll need for a down payment, you should research the real estate market where you plan to buy and get an idea of how much the average home in that area will cost. Once you have an idea of home prices, you can then determine how much you’ll need to save up for a down payment.
Ideally, you’ll always want to bring in at least 20% to avoid mortgage insurance, but this could be tough in areas where real estate is expensive. If you’re planning to buy in San Jose, CA, for example, a 20% down payment would be around $120,000 for a median-priced home. However, if you’re planning to buy in Louisville, KY, a 20% down payment isn’t such a formidable number.
And of course, if you qualify for VA financing, avoiding mortgage insurance is a non-issue. The size of your down payment will depend primarily on how much you want to spend at closing and the monthly payment you’re comfortable with.
The bottom line is that how much you’ll need to bring in for a down payment will depend on how expensive real estate is in the area you want to buy, how much you can save every month, and your time frame for purchasing a home. You should first go through your monthly budget and determine how much money you can reasonably save on a monthly basis. If you can save up $1,000/month and you live in an area where real estate is cheap, you can probably save up a 20% down payment in a very short time. However, if you live in an area where real estate is super expensive, then saving up 20% might take you the next 20 years, and it might make more sense to put down less as long as you’re comfortable with the payment that results.
The other factor you want to consider is payment affordability. Obviously, if you put down less, you’ll be borrowing more, which means you’ll have a higher monthly payment.
To recap, there’s really no easy answer for how much you’ll need to save up for a down payment. Ideally, you want put down at least 20%, but whether or not you can do that depends on how much home prices are in the area you want to buy, how much you can save on a monthly basis, what payment you’re comfortable with, as well as your time frame for buying a home.
Whatever number you come up with, make sure to allocate extra cash for closing costs. These can vary widely depending on the area you plan to buy, but it’s a good idea to at least plan for an extra 2% to 4% of the purchase price. It doesn’t mean you’ll actually need to spend that much, but it’s better to have more than you need than not enough.
To firm up your estimates even more, check with an experienced real estate agent or loan officer.
Get on a Savings Plan
Once you have an idea of how much you’ll need to save up for a down payment, it’s time to get on a plan to make that happen. If you’ve already paid off all your debt, hopefully you have some free cash flow you can set aside in savings for a down payment. Figure out how much your current budget will allow you save every month, and then divide that number into the amount you’ll need to cover a down payment and closing costs in the area you want to buy.
For example, if you want $20,000 for a down payment and you can save around $700/month, then you’ll need to save for around 28 months to build up the down payment you need.
If whatever time frame you come up with isn’t quick enough, then it’s time to figure out some extra ways to generate cash, either by earning extra income and/or by cutting expenses to accelerate your savings.
Another idea is to leverage the skills you have into a side gig that can earn extra money. For some ideas about how to do this, check out the following links:
- Give Steps to Finding Your Side Hustle
- The $100 Startup
- The 4-Hour Workweek
Just as getting a side hustle helps pay down debt faster, it can also help you save up a down payment much faster. If you have skills that you can use on the side to generate extra income, by all means take advantage of them and put whatever you earn into your account for your down payment. There a lot of opportunities for freelancing online (check out Elance and Odesk) doing things like web design, writing articles, taking surveys, proofreading, etc.
Preparing to Qualify for a Mortgage
Once you’ve saved up a down payment, you should keep the funds in a quiet account that gets very little deposit activity for at least 90 days in advance of applying for a purchase mortgage. Lenders will want to “source” and “season” the funds you’ll be using for your down payment, meaning they’ll want to document with bank statements that it’s been in the bank for at least 90 days.
It’s important to keep the funds in a quiet account with very little deposit activity to avoid some big paperwork headaches. If the bank statements you provide have a mess of unidentified deposits on them, which result from checks or cash you deposited or transfers from other accounts, then lender will require you to document them as well. This is a headache you’d rather avoid! This means gathering up additional canceled checks, receipts, and bank statements and sending them into the underwriter. If the additional bank statements you provide also have unidentified deposits, you’ll be asked to document those as well. Again, this is a headache you want to avoid!
Deposit your down payment and closing costs into a very quiet bank account at least 90 days in advance of applying for new mortgage. Once you’ve done that, don’t make any new deposits into the account.
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