Home ownership is one of the most common goals our clients share, and as Covid has reshaped what we need and want from our living spaces, interest in buying homes has only increased.
We work with all of our clients on the kind of financial basics that help with the home buying process, such as improving credit scores, establishing savings, and increasing income. We also help prepare clients for finding a good rate on a mortgage. These are great first steps, but eventually all prospective buyers have to make one of the most important decisions they’ll make throughout this process: how much to put down for a downpayment.
Since this is one of the most frequently asked questions with clients and followers alike, we’re going to tackle this issue and give you some tools for navigating this question.
A downpayment is a partial upfront payment made in the early stages of a large purchase. It is similar to a deposit, and is followed by a financial arrangement that will satisfy the rest of the debt.
Ideally you should have a downpayment of at least 20% of the asking price when you buy a home. The higher the down payment, the less interest you will pay over the life of the loan and the lower the mortgage payments will be. Bigger down payments also protect you from getting underwater on your mortgage.
While 20% is a solid best practice downpayment, many people do buy homes with less. There are three ways buyers most often do this:
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Putting less than 20% down on a conventional home loan. While we always recommend putting 20% down on a home to put yourself in the best possible financial situation post-purchase, there are some instances where this may not be possible. For instance, some people in very expensive housing markets can easily afford a mortgage but don’t have adequate savings. In rapidly developing markets, home prices might rise faster than buyers can save, making it desirable to lock in a lower cost purchase. It is possible to put less than 20% down, but then you’ll have to pay PMI, or premium mortgage insurance. This is an added cost, and protects the lender if you stop making payments. You have to pay PMI until your loan to value (LTV) is 78%, or in other words until you have more than 20% equity in your home.
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Getting an FHA Loan. FHA loans are mortgages intended for low to moderate income buyers with less than perfect credit and are insured by the Federal Housing Administration. FHA loans only require a downpayment of 3.5%, which opens up the possibility of homeownership to a much wider population. The plus side is that it can make downpayments much more affordable. The downside is that with such a small down payment, borrowers may pay high PMI, and the PMI on FHA loans lasts for the life of the loan. This means that many borrowers will want to refinance, which can be costly in the long run.
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Going through a First Time Homebuyers Program. There are lots of programs that aim to make home ownership possible for people of all income levels. Some are based on income, some are based on location, and others are based on commitments to serving particular groups of people, such as people living in a heavily gentrifying neighborhood or veterans. In the case of VA Loans for veterans or NACA loans for economically disadvantaged people, borrowers can get mortgages with favorable terms with no down payment. Many of these programs also come with (and sometimes require) counseling programs to help new homeowners successfully manage their new financial responsibilities.
You’ll need to do your research to see which option is right for you, and you’ll want to do the math to be sure that you understand what you can truly afford. Buying a home is one of the biggest decisions you can make about your finances (and your life!) so arm yourself with everything you need to make the best decision for you!
