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