Saving for a down payment for a home financing transaction can be a big hurdle for prospective homebuyers, particularly when they’re purchasing their first home. Many lenders and experienced homebuyers tout the benefits of making a 20% down payment, but that’s not actually the norm. Here are some first-time homebuyer tips to help you determine a how much you will need.
A down payment is the initial cash you put toward the purchase of your home. The money will typically come directly from the buyers’ savings, from a gift or from a grant. The down payment amount is typically expressed as a percentage; it is the amount of the down payment relative to the purchase price of the home. If the home costs $100,000, a buyer would need to pay $20,000 for a 20% down payment. With median home prices in the $300,000s, first-time homebuyers may need to save more than $60,000 to make a 20% down payment on a typical home!
Fortunately, it’s possible to secure home financing with a smaller down payment. Here are some different loan types and their required down payment percentages:
Conventional – 3% to 5%
FHA (Federal Housing Administration) – 3.5%
VA (U.S. Department of Veterans Affairs) – 0%
USDA (U.S. Department of Agriculture) – 0%
Each these loans types has restrictions or benefits. For example, VA loans are available for qualified veterans, while USDA loans are available only for buyers with low or moderate incomes in areas designated as “rural” by the USDA. Borrowers with lower-than-average credit scores often find FHA loans beneficial.
To take advantage of lower down payments, buyers pay mortgage insurance premiums, often referred to as PMI for private mortgage insurance or MI for government mortgage insurance, or other fees. For VA loans, a funding fee may be required at closing. For USDA loans, borrowers pay a guarantee fee upfront and annually. New FHA loans with a down payment of less than 10% require MI upfront and for the life of the loan. For down payments of 10% or more, MI is required upfront and for 11 years.
Many lenders tout the advantages of PMI with conventional loans, especially in times when home prices are rising quickly. These loans require the borrower to pay PMI until the loan balance is 80% or less of the home’s value, a percentage known as the LTV or loan to value ratio.
The LTV ratio improves through two scenarios. First, each monthly payment lowers the amount owed and adds to the homeowner’s equity, reducing the LTV. Second, as the home’s value rises with the market, the homeowner’s equity increases and their LTV drops. Over the last 30 years, home values have increased at a rate of more than 5% annually. In recent years, values have risen much more quickly, enabling homeowners to refinance at a lower LTV and drop PMI pretty fast. Many lenders offer calculators to help buyers see how quickly they may be able to drop PMI in various home price growth scenarios.
First time homebuyer tips must include a reminder that the down payment is not the only cash required to purchase a home. Closing costs typically require 2-5% of the cost of the home. Plus, homeowners will want to have funds to cover costs for moving, utilities deposits, and any updates they want on to make for their new home.
True Homes has many options that are eligible for 0% down payments with USDA financing. Check them out at www.truehomesusa.com.