Buying a home can be one of the biggest and most exhilarating purchases of your lifetime. Especially in a time when young people are having more difficulty locating affordable housing, finding yourself in a situation where you think you have finally saved up enough money for a down payment on your first home can be a huge milestone, but it can also bring up a lot of questions.
There can be times when simply figuring out how much money is required for a downpayment on any given loan program can put you into a tailspin. Though there are generally traditional numbers that many people stand by, there are many reasons to wonder if these guidelines still apply.
If you’re ready to buy your first home, you’ve likely heard that a 20% down payment on a mortgage has been the traditional standard. Generally speaking, putting 20% or more down on your new home can help lenders to view you as a less risky borrower, which may ultimately help you get a better deal on your loan terms.
But given that as of January 2020 the median home listing price was the U.S. is nearly $244,054, according to Zillow , 20% can be a substantial chunk of change for most people.
But is the 20% down sage advice or an opinion that’s no longer relevant? In the 2019 National Association of Realtor Profile Report , first time homebuyers financed 94% of their home and repeat buyers financed 84% of the purchase price. So, it seems that times are a changin’.
This article will review different loan programs and down payment options to hopefully provide clarity and demystify how different down payment options can impact your mortgage choices. These tips may help you better identify the loan programs that best fit your financial scenario to help put you on the road to owning your own home.
Why Does 20% Seem to be the Magic Number?
The simple answer is that there are some advantages to putting down that much. For example, it may be easier to secure a mortgage with better terms when putting down a larger amount.
A 20% down payment has traditionally been the gold standard for borrowing a mortgage. From a lender’s perspective, a borrower who can afford a 20% down payment is viewed as a less risky option from a credit perspective.
In addition, the amount of equity in the home allows for value fluctuations and the borrower is less likely to find themselves underwater or upside down on their mortgage in a declining market .
Plus, with a 20% down payment, you won’t have to buy private mortgage insurance (PMI). PMI benefits the lender in case of loan default which can cost anywhere from 0.140% to 2.33% of your total loan amount annually depending upon many factors.
Don’t confuse Private Mortgage Insurance (PMI) with FHA’s Mortgage Insurance Premium (MIP) which is government loan insurance, not private loan insurance.
And then there’s the most obvious perk: putting more money down up front means that you’ll owe less, which normally equates to lower monthly mortgage payments and less interest charges over the life of the loan.
But let’s face it: Even if you’re making a decent—heck, a pretty awesome—salary, saving up 20% of the total cost of a home can be difficult, especially if you’re paying rent, juggling student loans, and trying to reach other long-term goals, including saving up for a retirement. Today, it can seem that the goal of owning your home is close to impossible.
But think again.
There may be some very valid reasons why it might just be more beneficial for you to put down less than 20% on your dream house. Again, it will depend on your exact financial circumstances and long term goals, but it could be worth considering the following:
Preserving Your Nest Egg
Putting 20% down on a home might force you to rely heavily on funds you’ve worked hard to save, liquidating these funds, even for an investment, may not always be in your best interest.
Given the financial circumstances many people find themselves in, allocating a big chunk of change to put towards a house before you’ve covered your other important life expenses—such as an emergency fund, saving for retirement, and other important long-term financial goals— may not be the most prudent option for you in the long run.
Remember, you may be able to borrow money to pay for school, to buy a new car, and to buy a home, but you definitely can’t borrow money to pay for your retirement. So you may want to consider alternatives before you dip into your savings.
And if there aren’t any other options available, you may want to check that all of your other financial bases are covered.
While you can withdraw qualified funds up to $10,000 from a traditional or Roth IRA without penalty to buy your first home, there are still taxes to consider.
With a traditional IRA, you have to pay taxes on the amount you withdraw, but with a Roth IRA, no taxes will be due if you’ve had the account for at least five years. This strategy could help you in the long run, especially if you expect income boosts as you make strides in your career.
If you are considering putting other financial goals on hold in order to buy your home, it might make sense to take a step back and look at your overall financial profile. This could help you see what makes the most sense for your circumstances.
To be sure, there’s no hard and fast rule about how to manage your money since everyone’s situation is different. But if you’re considering buying a home and aren’t sure how to prioritize your other financial needs, taking the time to assess your unique situation could help you make the decision that satisfies your priorities now—without sacrificing the wellbeing of your future self.
Your Other Big-Ticket Goals Won’t be in Limbo
Buying a home can be tricky if you find yourself saddled with student loans or other debt. It’s important to keep in mind what is going to help you get the most stable financial footing possible, but arriving at this answer isn’t always straightforward.
By putting less money down on your home, you’ll likely be able to make more headway on other short-term financial goals, such as paying off student loans and credit cards, as well as your long-term goals, such as saving up for retirement or perhaps setting aside enough money to finally take that year-long sabbatical.
You may also be able to invest more, which could help you grow your hard-earned cash and, in turn, keep living expenses low during retirement.
If you have other important financial goals that need achieving, you may want to consider waiting until you’ve reached your other important goals before buying a home, or choosing to put less money down so that you don’t have to abandon your other important financial objectives.
Exploring All Of Your Options
The homebuying process can be tricky—especially if it’s your first time navigating the process. Buying a home can be a complex financial decision.
There are many nuances in each buyers’ financial situation, including the amount of existing debt they currently have, their income bracket, where they are at when it comes to other important financial savings goals such as retirement, and so much more.
One good place to start is to determine how much house you can afford by taking a look at your monthly income, your ongoing monthly expenses—which could include car payments, insurance premiums, credit card bills, and any other debts.
From there, you can determine what down payment amount would make the most sense for your circumstances and what loan programs you could potentially apply for using this amount.
Mortgage lenders, whether banks or mortgage brokers, are required to figure out a borrower’s ability to repay the loan before making it. Even so, lenders don’t normally take all monthly obligations into consideration when qualifying a borrower for a home loan.
You ultimately know your budget better than anyone else does, so it’s important to develop a firm understanding of where you are at financially and how much you want to—and are able to—pay every single month for a home until you own it outright.
Shopping for the loan program that’s right for you can be one of the most crucial steps in the home buying process.
Loan types determine things like—down payment amount, debt to income ratios, credit score and more. And though there are countless mortgage products out there, you’ll have to figure out what makes the most sense for your budget, lifestyle, and income.
The Magic Percentage Can Be Personal
Sure, 20% down payment might be the tradition. But looking at the current down payment percentages, we can see that it’s normally not a loan requirement. Certain circumstances could call for a larger down payment requirement from a lender, such as the type of property or the size of the loan.
Everyone’s financial picture looks different, and if you find yourself in a situation where you can’t afford to put down a full 20% but still want to purchase a home, there are numerous options.
To be sure, putting less than 20% down on a home isn’t for everyone. But if you’re in a great place in your career and still moving up, and have a lot of your other financial bases covered, there’s a chance that doing so may be right for you.
Be sure to explore the different loan programs and their criteria in order to help identify which programs best fit your personal situation. For instance, are you eligible for a Veterans (VA) loan which allows for 100% financing? Or a First Time Homebuyer loan which may allow for as little as 3% down .
Putting down a smaller down payment could allow you to get in the housing market if you live in a popular city where you pay high rent or where home prices have soared in recent years.
Renting in the Bay Area? Lower down payment options on a new home could be a path to homeownership. And just like when searching for the perfect home, when it comes to landing on the right loan program and down payment percentage, you’ll likely want to shop around in order to find your best fit—there’s no one size fits all.
So, no matter where you find yourself currently in your home-buying journey, it’s recommended to do your homework and weigh all the pros and cons to choose what works best for you.
Eager to get a jump on the home-buying process? Discover your potential rate on a SoFi mortgage loan in less than two minutes.
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