The Down Payment on Your First Home

If you’re in the market as a first-time home buyer, you’ll probably be concerned about your down payment. There is a lot of conflicting information and advice about how much you really need to have.  How can you effectively save money?

How Much Should Your Down Payment Be?

You’ll see a lot of advice suggesting you save 20% of the home’s purchase price for a down payment. This is not necessary. There are many loan programs available for first-time home buyers that do not require such a high down payment.

MIP or PMI

Mortgage insurance premium (MIP) from FHA (Federal Housing Administration), or private mortgage insurance (PMI) from conventional lenders is available for borrowers with less than 20% down.

The 20% is usually suggested to avoid the added cost associated with the price of the insurance premium, which specifically protects the lender in the event of default on the loan. If you use a conventional loan and have less than 20% down, this mortgage insurance is almost always mandatory.

It can be frustrating to pay this extra insurance premium because it only benefits your lender, not you. You’re covering the cost of extra insurance to reduce the lender’s risk, and that’s money out of your budget. This insurance typically costs 1% or less of the full loan amount—so if you have a $200,000 mortgage, and are paying .5% PMI, then you’ll pay $1,000 extra every year on your house payments toward this insurance coverage. If you pay 1% PMI, that’s $2,000 per year, or an extra $166 every month. That’s money you could be putting toward savings, paying down debts, or other productive uses.

FHA Mortgage Insurance

The Federal Housing Administration, generally known as FHA, provides mortgage insurance (MIP) on loans made by FHA-approved lenders throughout the United States and its territories.

People getting FHA mortgages (a great option for first-time borrowers) will pay for FHA mortgage insurance. It’s similar to PMI, but with different rules and costs. Generally, MIP is going to be between .45 and 2% of the loan amount, and if you put less than 10% down, you’ll have to pay for this coverage. So you can think of FHA mortgage insurance the same way you’d evaluate PMI.

Because of the added cost of mortgage insurance, many people advise saving up to 20% of the home’s purchase price, so when you buy your home, you don’t have to pay any MIP/PMI. This seems like sound advice at first, but when you do the math, it turns out that you get a better financial return by getting into home ownership right away, even if you put less than 20% down. The first few years of homeownership, which you would otherwise spend saving up a 20% down payment, will help you build equity and take advantage of property value appreciation. This time as a property owner is crucial, and it’s the main reason people should become homeowners sooner rather than later.

The bottom line is that it’s a myth that you need to save up to 20% for a down payment. Check out this link to see an infographic that will show you the numbers.

If it’s not 20%, then what’s the right amount?

With an FHA loan, you might typically need around 3.5% of the purchase price to buy a home. This is a much more manageable amount to save up, and should leave you some room for closing costs and other expenses related to getting into your new home.

That means the real answer depends on how much you intend to borrow. Once you know that amount, you’ll have a target to save for—3.5% for a down payment, and at least another 3% for closing costs. If you are looking at a home for $200,000, plan to save up at least $13,000 initially. That’s quite a bit better than having to save up $46,000 if you’re aiming for 20% down (20% of 200,000 is $40,000, plus $6,000 for closing costs).

Every situation is unique, though. Property values are very different across the country. Start with our “How Much Home Can You Afford?” mortgage calculator, to get an idea of what you can afford. Then figure 3.5% of that, plus another 3% for closing costs. Anything extra you can accumulate is great, as there will always be unexpected expenses that pop up when you’re buying a home.

USDA and VA Loans

There are some loan scenarios where borrowers can put down as low as 0%. If a home buyer is an active member of the military, or they qualify because of certain kinds of veteran status or live in particular rural areas, then there are 0% down loans from the Veterans Administration or the US Dept. of Agriculture (USDA).

Talk to your lender about VA loans if you are a veteran, or your spouse died while on active military duty—requirements and loan amounts may vary from state to state and from one lender to another.

USDA loans are offered through the Rural Development Guaranteed Housing Loan Program. Like FHA and VA loans, they are offered by a participating lender and backed by the government, which means you can put less money down, even as low as 0%, and with low or no mortgage insurance requirement. If you’re buying in a rural area, ask your lender about USDA loans to see if you qualify.

Other Assistance Plans

There may be local down-payment assistance plans, depending on your state, county, and city. Your local lender or a HUD-approved housing counselor can help you find out if there is anything available to you.

There also might be assistance offered by Fannie Mae and Freddie Mac.

In all of these types of homebuying assistance, there are many terms & conditions to navigate, so it’s likely you’ll find it all overwhelming. A homebuying counseling can help you cut through the noise and identify the best programs to assist you.

First-Time Homebuyer Down Payment

Once you’ve figured out a target amount, how do you save up the funds needed for your down payment? Here are some tips:

• Open a 2nd savings account. Create a separate account to save up your down payment. Don’t make it too easy to dip into those funds for other reasons. It’s really important that you demonstrate that you’re able to consistently put extra money aside because besides accumulating the down payment you need, you’ll prove that you’re financially ready to handle homeownership.
• Eliminate debts. Every other debt you pay is costing you money in interest that could be going toward your down payment. Pay down your debts, and put the money you were devoting to interest payments toward your down payment.
• Go on a budget. This is something everyone should be doing anyway, for the good of their household finances. Create a budget (learn how from our FIT Academy), and track all of your spending to be sure you can handle a mortgage payment and the other costs of homeownership.
• Move investments. If you’re saving up in one investment vehicle, you may determine that it’s better to move that investment toward homeownership. We don’t advise home buying as a short-term investment option, but if you’re building home equity over time, you’re getting started on a lifetime investment. The goal is to own the home by the time you retire, so you won’t have a mortgage payment when you transition to a fixed income. Since this is a kind of retirement investment, some people borrow from their 401(k) to help fund a mortgage down payment. We don’t recommend this if there are penalties involved, though. If you have a penalty-free way to borrow against your retirement plan for home buying, talk to a mortgage coach about whether that’s a good choice for you.
• Handle personal borrowing and gifts carefully. You can fund your down payment with a gift from family, or personal loans, but you must disclose where the money comes from—first-time homebuyer programs typically want to be careful about borrowers who rely on a lot of gifts or personal loans to get into homeownership.
• Get help from the seller. The person selling you your first home can help pay your closing costs from the proceeds of the sale. They might do this to help make sure the sale goes through. A seller can’t help you with your down payment, but if they cover closing costs, then the extra money you saved for that purpose can be added to your down payment fund. Freddie Mac published a survey recently that showed 16% of home buyers get help from the seller in this way, so it’s actually pretty common. Your lender and real estate agent will likely have dealt with kind of seller assistance before, so talk to them about how this might work, and whether your seller might be willing to participate.
• Proceeds from your home sale: once you’re a homeowner, this whole process becomes much easier. When you buy your 2nd home someday, you will have money from the sale of your current home to put toward your next property. You’ll be much more likely to be able to put 20% down and avoid PMI charges on your next home. That’s why it’s important for first-time home buyers to get into home ownership as soon as they can and start reaping the benefits.

The question of how much to save on a down payment is most crucial for buying your first home. The amount you put down vs. the amount you borrow will have a big impact on your monthly mortgage.

Debt to Income Ratio for Home Loan

The debt-to-income ratio (DTI) for a loan is expressed as a percentage. Generally, lenders don’t want to see a borrower spend more than 28% of their monthly income toward housing expenses, and the total of all the borrower’s debt repayment, including the mortgage, should be 36% or less of their monthly income.

You can learn more about debt-to-income ratios and how to calculate yours here.

First-Time Homebuyer Tax Credit

The first-time home buyer act is a proposed law that is currently being debated but has not been passed yet. This proposal would create a first-time home buyer tax credit for qualifying borrowers. The amount has not been set, but the current proposal would start with a $15,000 tax credit toward the first-time purchase of a home, provided the borrower meets certain requirements:

• Income is limited by area
• First-time purchase of a primary residence
• Must be 18 years or older
• Cannot be purchasing the home from a relative
• First-time homebuyers would include anyone who has not owned a home within 3 years

State-by-state programs

While the federal First-Time Homebuyer Act has not been passed yet, states and localities have first-time home buyer programs. As a HUD-approved housing counseling agency, we get questions about many different programs. Some of the states we are asked about most often include;

• First-time Homebuyer Ohio
  • Ohio offers special programs through the Ohio Housing Finance Agency, Office of Housing and Community Partnership, with local programs in cities like Akron, Cleveland, Canton, and Massilon, and county-wide programs in Lucas (Toledo), Hamilton (Cincinnati), Franklin (Columbus), Montgomery (Dayton) counties, and more. HUD has more state specific  
• First-Time Homebuyer PA
  • The Pennsylvania Housing Finance Agency offers multiple kinds of assistance, and there are local programs in many cities and counties throughout the state. Check out more info from HUD.
• First-Time Homebuyer NJ
  • The New Jersey Housing & Mortgage Finance Agency (JNHMFA) offers a Down Payment Assistance Program for First-Time Homebuyers. The New Jersey Housing Resource Center is another good resource, and HUD offers info on city and county resources throughout the state.
• More First-Time Homebuyer Resources
  • In every state, there are resources like Habitat for Humanity that helps families in need acquire housing, VA programs for veterans, USDA loans for rural home buyers. A HUD-approved counselor can help you find resources close to you.

Wherever you are, buying your first home can be tough to navigate. Fortunately, there is a lot of expert help available—an entire industry of housing counselors and mortgage professionals are invested in seeing you succeed. You can get homebuyer education and personal pre-purchase coaching that will help answer all of your questions, even those specific to your city and state. Get help today to create a plan to have a home of your own.

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