A traditional mortgage generally requires the buyer to place a down payment of at least 20% of the purchase price, but with recent changes, lenders have made it possible to purchase a home with as little as zero down (though these sort of options are becoming fewer and far between). In order to receive the best possible interest rates and to avoid private mortgage insurance, it is still a wise decision to have a significant down payment. But how can you get started on saving tens of thousands of dollars for this purchase? Here’s your mortgage down payment how to.
How Much Should You Save for a Down Payment?
The magic number that is most commonly referenced in the world of mortgage financing is 20%. With a down payment that is equivalent to 20% of the purchase price, lenders will not require you to purchase Private Mortgage Insurance (PMI), which is an additional cost built into your mortgage that protects the lender in the event of a default.
Ideally you would like to be able to save up a 20% down payment in order to avoid the additional cost of PMI and to build equity in your new home, but that can be a daunting task. For instance, with a home priced at $200,000 you are looking at coming up with $40,000 just for the down payment, which doesn’t include closing costs or other expenses related to securing a mortgage and purchasing a house. The good news is that if you do come up with a substantial down payment, you have instant equity in your home which can be valuable down the road when you decide to sell the home.
Though 20% of the purchase price should be you goal, you don’t have to let the 20% rule keep you from owning a home. While it is to your advantage to save money by avoiding PMI and to build equity into your home as quickly as possible, you may be able to find the home of your dreams and save money with a smaller down payment. When weighing your mortgage options, be sure to consider all of the various costs associated with the loan and choose the option that is best for you in the short-term and in the long-term.
Sources of Down Payment Funds
When you begin planning for the purchase of a home there are many possible sources for the funds you will need for a down payment. Typically the down payment will come from a source of cash savings, but there are other options available.
Check with the Federal Housing Administration or Veteran’s Administrationas well as state housing authorities for programs that can assist first-time and low to moderate income families to obtain a mortgage with a lower down payment. The U.S. Department of Agriculture’s Rural Housing Service also offers a program intended to encourage low to moderate-income buyers to purchase in rural areas.
If you currently have money saved up in retirement accounts, there may be additional resources available to you as well. Some 401(k) and 403(b)retirement plans allow participants to borrow money from the account for a new home purchase. Additionally, if you have an IRA account there are provisions to allow withdrawals for first-time home purchases.
Unlike other loans, a 401(k) loan will not count in your debt-to-income ratio when you apply for a mortgage and it will not affect your credit score. That said, there are some big consequences if you fail to repay the loan including paying income taxes on the amount you borrowed and possibly an early withdrawal fee of up to 10%. And if you leave your job while in repayment of your 401(k) loan, you may only have 60-90 days from termination to pay it off completely. The other costs of such a loan is the opportunity costs. How much growth on your retirement assets are you missing out on by borrowing that money? These are all considerations that must be thought through.
Put Your Savings to Work
If you plan on going the most traditional route and are saving money for a down payment, you want to make sure it is working for you. Money that is sitting in a savings account earning less than 1% interest won’t do much in regards to helping you reach your savings goal faster. If you have a time frame set for when you plan on purchasing the home, there are a few options for your money to make money while you wait.
If your plan is to purchase a home within the next few years you may want to look at a high-yield savings or money market account for holding the down payment funds. Currently, you can receive rates up to 2% APY on these types of accounts. Another option could be to put the money into acertificate of deposit (CD). You have less flexibility and liquidity with these accounts, but the principal protection and yields can be attractive when compared to a typical savings account.