Navigating a house purchase isn’t easy, especially the financing. The first variable in that long equation is the down payment.
There are lots of factors to consider about a down payment. The most pressing: How much do you need?
Here’s our handy guide to down payments for first-time home buyers.
How Much Down Payment Do I Need?
People tend to think of down payments as fixed amounts of 20% to 30% of a home’s purchase price. And while this is a good goal, it’s by no means a set rule.
“A common misconception is that you have to put 20% down,” says Brittany Hovsepian, owner of The Expert Home Buyers. “That’s simply not the case — some people don’t even have a down payment at all.”
One thing to keep in mind when determining your down payment, is that anything less than 20% will likely have your lender asking you to take out something called private mortgage insurance (PMI).
PMI policies protect lenders in case you default. The thinking is that the less you put down, the more you might be willing to walk away.
PMI is usually included in your monthly mortgage payment and typically cost between 0.5% and 1% of the total value of your mortgage. Since this isn’t an insignificant sum to pay over the lifetime of your mortgage, it’s worth taking into consideration.
According to a recent survey from the National Association of Realtors, only one in three first time homebuyers actually manage to make a 20% down payment.
In the current housing market many buyers are offering well over the asking-price, which can significantly drive up the cost of a down payment. And despite only one third of first-time home buyers making 20% down payments, of the total number of buyers taking out mortgages, 52% are putting at least 20% down. Translation? There’s more pressure than ever to pay what you can for a home.
So how do you go about deciding what you can afford for a down payment?
How Down Payments Affect Mortgage Payments
Since your down payment is ultimately a portion of your mortgage, how much you end up paying at the outset will also affect how much you owe later in monthly mortgage payments.
Knowing this, you’ll want to settle on a down payment that makes sense for you at the outset and makes those monthly payments affordable. If either of those things start to feel impossible, that might mean you need to consider buying a more affordable home.
“I’ve always found a good starting point to evaluate how much house you can afford is to insert your projected monthly costs into a hypothetical 50/30/20 budget,” says R.J. Weiss, a certified financial planner and founder of The Ways to Wealth.
Using this formula, 50% of your budget goes to needs, 30% goes to wants and 20% toward savings. “If your mortgage payment puts you above 50% in the needs category, chances are that payment may be hard to make down the road.”
Of course, a big part of your monthly mortgage payments will depend on the interest you end up paying — which, in addition to being determined by the amount you put on a down payment, will also depend on your creditworthiness. If you’re still in the early stages of shopping around for homes, tools like this free interest rate calculator can help provide a rough idea of what you might expect to pay based on your location, credit score and the type of mortgage you need. If the interest rate seems high, you might need to spend some time improving your credit score.
Other Buyer Expenses: Don’t Forget Closing Costs
Future mortgage payments aren’t the only other expense you should consider when shopping for homes. There are a lot of other fees that go into closing the deal, and they are almost always paid by the buyer.
“Closing costs will include things like title insurance, taxes, HOAs, and even attorney’s fees,” says real estate agent Mihal Gartenberg of Warburg Realty in New York City.
Closing costs generally run between 2% and 6% of the home purchase price. So if you’re buying a home that costs $350,000 and you’d like to make a 20% down payment— you should plan on saving at least $91,000 ($70,000 for the down payment and $21,000 for closing costs).
It’s often possible to fold closing costs into your loan, but that means you’ll ultimately pay for them longer and with interest.
How to Save for a Down Payment
Saving up for a down payment (and all the associated closing costs) is no small feat. Depending on your income, how soon you’d like to buy a home and what price range you’re targeting, the amount you need to save will vary quite a bit.
The most important thing to do before you even start shopping for homes is to set up a savings routine that works for you. “If you’re looking to save up for a downpayment, the first step is to create a budget and stick to it,” says Gartenberg. “Put your money away the minute you get your paycheck so you don’t spend it, and take a hard look at your spending habits to cut costs wherever possible.”
Consider opening up a high yield savings account for your house fund, and find creative ways to automate your savings. By starting these good savings habits long before you need the money, you’ll be on track to make a down payment that saves you a lot of money over the life of your mortgage.
Contributor Larissa Runkle specializes in finance, real estate and lifestyle topics. She is a regular contributor to The Penny Hoarder.