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One of the traditional ideas about buying a house is that the buyer needs to make a large down payment. Often, 20% of the purchase price is cited as the standard for a down payment, but the truth is that many buyers put down much less. Here's a look at the reasoning behind this and why a 20% down payment isn't right for everyone.
When you take out a mortgage to buy a home, many lenders will expect you to make a down payment. The payment is calculated as a percentage of the overall cost of the property. So, if you're planning to purchase a house worth $200,000 and you make a down payment of $10,000, you would be putting down 5% on your home.
Many financial institutions consider down payments as an important test of your financial stability. They show the bank or credit union that you can save money over a period of time and that you have the financial resources necessary to afford a mortgage.
The size of your down payment can affect the terms of your home loan. This is because your monthly mortgage payments and interest costs are calculated based on the amount of money you owe the bank for the property you're buying. For instance, if you make a 20% down payment on a $100,000 home, you'll still have to pay off $80,000 on your mortgage. By contrast, a buyer purchasing the same home with a 7% down payment will still have $93,000 to pay off during the lifetime of their mortgage.
As we explained earlier, the traditional goal for many home buyers is to put down 20%. There are many good reasons in favor of doing this. A large down payment can reduce your monthly mortgage payments, which leaves more money in your pocket at the end of each month.
Another related benefit is that the total interest over the lifetime of your mortgage will be lower, since you'll be borrowing less money than someone who puts down a smaller percentage. The fact that you're borrowing a lower percentage of the home's total value may encourage your lender to offer you a better interest rate. One reason for this is that they may consider the loan to be less of a risk.
A third benefit of making a larger down payment is that you'll have more equity in your home. Equity means the percentage of the home that you own, as opposed to the percentage you still need to pay off with the bank. Higher home equity can prove helpful if you plan on selling your property in the years to come.
Higher home equity can also help you avoid charges associated with mortgages with lower down payments. For example, many home loans taken out by purchasers who make small down payments have what's known as private mortgage insurance (PMI). PMI is a monthly fee charged by the lender as security against the buyer's inability to pay. Buyers who make a 20% down payment generally don't have to pay PMI.
A final benefit is that you'll be able to afford a more expensive house if you put 20% down. For example, based on a monthly mortgage payment of $1,000, including both the principal and interest, a buyer who puts down 20% can secure a home loan worth about $100,000 more than someone who puts down 3%.
One of the biggest drawbacks to a 20% down payment is that you may overstretch your financial resources to acquire the funds to do so. If you use all your savings to put down 20%, you may have nothing to fall back on in the event of an emergency or unexpected expense. This may be one of the reasons why many home buyers refrain from putting down a large down payment. According to the National Association of Realtors' confidence survey, only around 28% of first-time home buyers put down 20% during the first quarter of 2021.
Most home loan programs specify a minimum down payment that a buyer has to make to be eligible. A standard commercial loan with PMI usually requires a minimum down payment of 3%. If the buyer wants to avoid PMI, they must put down at least 20%.
The Alliant Advantage Mortgage program has low down payment options, including as low as 0% down for first-time home buyers.
Other special home loan programs have different terms. Loans backed by the VA or USDA have no down payment requirements, but these loans are only open to certain people. VA loans are available to military veterans, while the USDA backs loans for house purchases in rural areas.
Loans backed by the FHA (Federal Housing Administration) require a minimum down payment of 3.5%. One advantage of a loan backed by the FHA is that they often have lower interest rates than conventional loans.Even if you can't afford a down payment, there are options for you to become a home owner. Many states offer down payment assistance programs, which provide funds to low-income people to make purchasing their own home a realistic goal.
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Want to learn more about buying a home or securing a mortgage? Check out these helpful articles from our blog:
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