When you start buying a home or investment property, one of the first questions you need to ask is how much down payment you want to make. For reference, the average down payment for a home was 12%, with a lower average (6%) for first-time home buyers. However, paying a larger down payment can help you start building equity faster.
What is a Down Payment for a House?
A home down payment is a flat rate you pay that is a percentage of the total cost of the home when the remainder of the payment is in the form of a mortgage. You pay your down payment at the same time you take out your mortgage loan. It is required for at least two reasons, both of which are related to how risky it can be to provide you with a mortgage loan. Firstly, it increases your investment and secondly because it means the lender is more likely to recoup their losses if they recapture your home for lack of payments.
For example, suppose you buy a home for $ 100,000 from a lender who ideally wants a 20% down payment of $ 20,000 (this is a hypothetical situation, not the actual down payment required). Your $ 20,000 is now tied to that home purchase, for better or for worse. So you have good reason to keep paying for the house and keep it on your behalf. However, if you stop paying, the lender only has $ 80,000 left so they can sell the home for less than your purchase price and still get their money back.
Minimum deposit requirements by mortgage type
With a traditional loan, your minimum down payment may depend on a few factors. If it’s backed by a semi-public lender and fits into certain programs, you might only have to pay down 3%. For other conventional loans, your lender may charge different interest rates, although the usual down payments required are in the 5% to 15% range.
The Federal Housing Administration offers 3.5% down payment loans to qualified borrowers, and the Veterans Administration and the United States Department of Agriculture each have loans that do not actually require a down payment at all. These loans all have additional terms from location and credit requirements to veterans or active members of the United States Armed Forces.
Getting the lowest down payment possible often involves meeting credit requirements, paying additional fees on completion, or paying for private mortgage insurance (PMI). If you can save a little longer at the start of your loan and pay a larger down payment, it can sometimes save you money in the long run.
Advantages of larger down payments
Your decision to make a larger down payment will improve your mortgage loan by making it smaller, but it also has some other valuable implications for your buying experience.
- Better interest rate – Lenders see you at less risk when your down payment is higher, which can qualify you for the lowest interest rates.
- Lower fees – Some loans allow a low down payment with PMI only, which adds fees. Higher down payments offer the option to waive these or other fees.
- Higher equity right from the start – Your own investment is safer when you have a large down payment because you have more equity. People with very low down payments are more likely to go underwater or owe more than the value of the home when the values go down. Large down payments give you a substantial buffer to prevent this from happening.
- Lower monthly payment – Since your total mortgage equity is lower with a high down payment, you have less ongoing payment obligations, which can be helpful for your cash flow.
How does your down payment affect the loan-to-value ratio?
An important number when buying a home is your loan-to-value ratio (LTV). Typically, when the principal of your loan is 80% or less of the total value or purchase price of your home, you will no longer have to pay for private mortgage insurance, which is a significant saving. So by paying a large down payment, you can get closer to a good LTV faster.
There are times when home values drop at least slightly and a good LTV ensures that you are not tied to a home that is worth less than the price you will pay for it during the life of the loan.
What is the Average Down Payment for a Home?
The average down payment was 12% of home purchase in 2020, according to the National Association of Realtors. This rate should remain stable in 2021. If the Biden government introduces first-time home buyer tax credits, the average down payment for first-time home buyers could increase (6% in 2020) to take full advantage of the credit available. If mortgage rates stay relatively low, the down payment may decrease as there is less incentive to prepay large down payments when you can get a very low interest rate even without them. Low mortgage rates also motivate people to refinance their homes at a better interest rate after paying off the loan for a while.
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