Navigating a home purchase is not easy, especially with financing. The first variable in this long equation is the down payment.
There are many factors to consider when making a deposit. Most urgently: how much do you need?
Here’s our handy guide to making deposits for first time buyers.
How much deposit do i need?
People tend to think of down payments as fixed amounts of 20% to 30% of the purchase price of a home. And while this is a good goal, it is not absolutely necessary.
“A common misconception is that you are to have by 20%, ”says Brittany Hovsepian, owner of The Expert Home Buyers. “That’s just not the case – some people don’t have a deposit at all.”
According to a recent survey by the National Association of Realtors, the average down payment for first time buyers was only 7% in 2020.
The type of loan you get can also affect how much you need for a down payment. Some of the most common mortgages are conventional FHA and VA loans.
One thing to consider when determining your down payment is that if less than 20%, your lender is likely to ask you to take out what is known as Private Mortgage Insurance (PMI). PMI policies protect lenders in the event you default. They’re included in your monthly mortgage payment and typically cost between 0.5% and 1% of the total value of your mortgage. Since this is not an insignificant sum to be paid over the life of your mortgage, it is well worth considering.
How do you decide what down payment you can afford?
How Down Payments Affect Mortgage Payments
Since your down payment is ultimately part of your mortgage, the amount you pay at the outset also affects how much you owe later on on monthly mortgage payments.
That being said, you want to settle for a deposit that makes sense to you from the start and makes these monthly payments affordable. If any of these things feel impossible, you may need to buy a cheaper home.
“I’ve always found a good starting point to evaluate how much house you can afford to fit your projected monthly costs into a hypothetical 50/30/20 budget,” said RJ Weiss, certified financial planner and founder of The Ways to wealth.
With this formula, 50% of your budget goes to needs, 30% goes to needs, and 20% goes to savings. “If your mortgage payment gets you over 50% in the need category, the chances are that paying will be difficult later.”
Of course, a large part of your monthly mortgage payments will depend on the interest you end up paying. This depends not only on the amount you pay for a down payment, but also on your creditworthiness. If you are still in the early stages of home shopping, tools like this free interest calculator can give you a rough idea of what you can expect to pay based on your location, your creditworthiness, and the type of mortgage you need. If the interest rate seems high, you may need to spend some time improving your credit score.
Other Buyer Expenses: Don’t forget about closing costs
Future mortgage payments aren’t the only other costs to consider when shopping for a home. There are many other fees involved in closing the deal and they are almost always paid by the buyer.
“Closing costs include things like property insurance, taxes, HOAs, and even legal fees,” says Mihal Gartenberg, real estate agent of Warburg Realty in New York City.
The closing costs are usually between 2% and 5% of the purchase price. So if you buy a home that is $ 350,000 and want to pay a 20% down payment, you should save at least $ 87,500 ($ 70,000 for the down payment and $ 17,500 for the closing cost).
It is often possible to include closing costs in your loan, but that means you will end up paying them longer and with interest.
How to save for a deposit
Saving for a down payment (and any associated closing costs) is no small feat. Depending on your income, how fast you are looking to buy a home, and what price range you are aiming for, the amount of money you need to save will vary significantly.
The most important thing to do before you even start home buying is to set up a savings routine that works for you. “If you want to save on a down payment, you first have to create a budget and stick to it,” says Gartenberg. “As soon as you get your paycheck, put your money away so you don’t spend it, and carefully review your spending habits to cut costs wherever possible.”
Consider opening a high yield savings account for your home fund and find creative ways to automate your savings. If you start with these good savings habits well before you need the cash, you are on the right track to making a down payment that will save you big bucks over the life of your mortgage.
Larissa Runkle is an employee of The Penny Hoarder.