Monday, 31 December 2018
If you're shopping for a new home, you are likely thinking about how much of a down payment you'll be able to put down.
When it comes time to apply for a mortgage, how should you decide what your down payment should be? When you're making such an important decision, there are a few factors to consider.
The magic number for most down payments is 20 percent. Why? Because those who make a down payment of at least 20 percent will be able to avoid the additional monthly expense of private mortgage insurance (PMI).This type of insurance protects the lender in the event you are not able to make payments.
PMI is usually paid on a monthly basis as part of your mortgage payment. In most cases, PMI is calculated as a percentage of the mortgage loan amount, usually between 0.3 percent and 1.5 percent of the original loan. The price varies based on the size of the borrower's down payment and credit score.
Similarly, borrowers with FHA loans (issued by the Federal Housing Administration) must pay a mortgage insurance premium (MIP) at closing, as well as an annual premium which is collected monthly. With VA loans (issued by the U.S. Department of Veterans Affairs), there will be an upfront funding fee, but no annual or monthly premiums. To understand the cost of these fees, borrowers should contact their lender.
If you have close to 20 percent saved for your down payment, it may make sense to draw on every possible resource to reach that amount. Otherwise, you may decide to consider purchasing a less expensive home so you can avoid PMI or delaying your purchase until you have enough money saved.
Should I make a bigger down payment?
In some cases, borrowers may be able to qualify for lower interest rates when they make a down payment of 25 percent to 30 percent of the purchase price. Borrowers should check with their lender to see if lower rates are available for loans with higher down payments.
Another benefit of bulking up the down payment: It will reduce a borrower's monthly payments and interest charges.
That said, paying more than 20 percent down on a home may not be the best option for your situation. For instance, do you have outstanding debts with higher interest rates? You may ultimately save more money by paying down higher interest debt than by bulking up your down payment. Check with a trusted financial or real estate adviser to see what's best for you.
For many prospective borrowers, a 20 percent down payment just isn't possible. But other options may be available to you through both government and conventional loan programs. Some government loan programs require no down payment or mortgage insurance costs.
Most conventional mortgages require PMI if the borrower can't make a 20 percent down payment. But, depending on your line of work, you may qualify for mortgage products designed specifically for certain groups of professionals that require little or no down payment and no PMI.
For instance, many lenders have products created for physicians starting their residency or attorneys fresh out of law school who have joined a firm. These potential borrowers likely carry more school loan debt that an average customer, but they also typically see a dramatic jump in income as their careers advance.
If, however, you don't fit in those categories and are required to purchase PMI with your mortgage, keep in mind that lenders will drop the PMI once your loan balance drops to 78 percent of your home's original appraised value — if you must meet certain requirements such as being current on your payments.
By understanding the costs and benefits associated with your down payment, you can choose the right amount for your needs—potentially saving thousands of dollars over the life of your loan.
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