Down payment is one of the upfront payments we need to settle when taking out a mortgage to buy a home. Deciding how much to put on a down payment as a first-time homebuyer is important as it affects your finances when you buy a home and all throughout the life of your loan.
Most lenders prefer if a borrower can put at least 20% down when taking out a mortgage to buy a home simply because it reduces their risk when lending a significant amount of money. But it doesn’t mean that you cannot put a down payment below 20%. The majority of homebuyers find it hard to save for that “ideal” percentage. In fact, the average down payment that most people paid to buy a home in 2018 was only 5.37% of the median home purchase price of $270,000. That’s too far from the “safe zone” that most lenders consider.
While there are several loan programs that allow you to put less than 20% down, you may also benefit in several ways if you can pay a larger amount down to buy a home.
More down means better mortgage interest rates
Historic low mortgage interest rates are all over the news which can give you a rough estimate of how much a lender would charge you if you’re going to borrow funds to buy a home. The interest rate you’ll get depends on how much you’re willing to put for a down. Typically, lenders will charge you a lower interest rate if you choose to put a larger down payment simply because it reduces their risk when lending you money. When taking out a mortgage, it’s important to know that the amount of down payment you’ll hand over is just one of several factors that a lender considers when charging an interest rate. Lenders will also consider the loan term you prefer, your income, credit score, and debts when determining the interest rate they will offer you.
However, regardless of how much down payment that you want to put, it’s also advisable to shop and compare rates from several mortgage lenders so you can get the most affordable rate and choose the right lender for you. Because buying a home is a big investment, most first-time buyers find it ideal to consult with a loan advisor to help them better understand their options.
A larger down payment means smaller loan balance
Your down payment determines how much loan balance you’ll have to pay through the course of your loan. Putting a larger down payment reduces your loan balance. Starting your mortgage with a smaller balance, or loan-to-value (LTV), protects your home from unexpected market value decline(s). When you put more money down, you are immediately building home equity or the portion of the home that you truly own. In a better market condition, building home equity can help you achieve your financial goals as a homeowner. After several years of repaying your mortgage, you may reap the rewards of your investment. You can tap your equity to consolidate debts, fund your child’s college education, or improve your home to make it energy efficient.
When buying a home, it’s important that you determine the down payment that you’re comfortable to afford. Aside from the down payment, you need to also prepare for the closing costs that you pay upfront when buying a home. While there are loan programs that allow you to put a down payment below 20%, a larger down may help you get a more favorable interest rate and enable you to immediately build home equity.
In the second part of this two-part series, we’ll explain why putting a larger down is beneficial as you pay your mortgage.