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How much cash do I need to buy a home?
The down low on your down payment
If you’re a wildly successful international recording artist or the CEO of a Fortune 500 company, you can probably buy a pretty nice home with the spare change you find in your couch cushions. Most of us, however, will have to take out a loan to pay for a house. Applying for a housing loan can be a tricky process, a mixture of data that includes your credit score and other financial information, but one factor that can influence several aspects of your loan is your down payment. And you might be wondering how much down payment for a house is necessary?
What is a down payment?
A down payment is the amount of cash you brought to the table when you set up your loan. To put it another way, it’s the amount of money you put down (and now you see where the term “down payment” comes from!). The banks, however, have different criteria as to how much will your contribution be in owning that asset.
In some cases, you can get a loan with no money down, and occasionally, people can buy houses without getting a loan at all by paying for the entire thing in cash.
These circumstances are pretty rare, though, and most of us will need a down payment of some kind. It shows the bank that you have the financial discipline to save up the money in the first place, and that gives them confidence in lending to you.
A down payment also saves you money in the long run. If you put down, say, 10% of the value of the house up front, then you won’t have to borrow that amount and pay interest on it, so it’ll save you money, too.
Why do banks want down payments?
One of the biggest reasons why the bank or lender wants your down payment is that it wants to know you’re invested in the loan. In other words, the lender wants insurance that you won’t default on your loan.
Putting down a chunk of money — say, 20% of the total — they know you’re invested in the transaction. In other words, if you put nothing down, it’d be pretty easy for you to just walk away from the loan. After all, you wouldn’t be losing much! But by putting down a large chunk of cash, you’re letting the lender know that you’re willing to risk it.
Now, if you try to bail on loan payments, you’ll have to walk away from that bundle of moolah you put down. The banks know you’ll think twice before doing this, so they have more confidence in giving you the loan.
Why is a down payment good for me?
The down payment is going to make you more attractive to the banks. Banks have a lot of information about you (including your credit score, which represents your history of borrowing money and paying it back), but they also want you to show them that you’re financially stable. If you have the money to make a sizable downpayment, they’ll be more confident that you’ll have the money to pay back the loan. A lot of banks will even reward you for making a large down payment. Often, the bigger the down payment, the lower the interest rate they’ll give you, which means you’ll end up having lower monthly payments over the life of your loan!
What does my down payment affect?
When deciding how much down payment for a house is necessary, it’s important to keep in mind the amount of your down payment will affect the principal of your loan. No, this principal isn’t the same one who wanders the halls of a high school encouraging teachers and students to do a good job! Instead, the principal represents the amount you still owe on your loan.
Let’s take a look at a concrete example. Say you’re looking to buy a house that costs $200,000 and you’re hoping to get an interest rate of 3.75 percent for a 30-year mortgage. As you can see in the chart below, the more you put down up front, the more you can save over the course of the loan:
|Money down||Balance||Total paid over 30 years|
In fact, if you’re wondering how much a larger down payment could save you over the life of your loan, there are a lot of great mortgage calculators online. Just put in the balance of the mortgage, the interest rate, and the length of the loan. Then hit the button and BAM you’ll see how much you’ll save if you put more money down.
Some people find the math involved in loans and interest to be a bit confusing, but these days, there are plenty of tools out there to help even the biggest math-phobes figure out the nuts and bolts of their loans.
How much should I have on hand?
So, how much down payment for a house is enough? Again, this will be a bit of a negotiation between you and your bank. They’ll have a number that they want you to put down, and you’ll have a number that you’re comfortable with. The goal is to try and find a happy medium that works for all parties.
One thing to keep in mind is that lenders and borrowers often think about down payments in terms of percentage, rather than raw numbers. So, rather than say something like “You need $50,000 for your down payment,” you should think about your down payment in relation to the total amount of the loan. A $50,000 down payment would be quite huge for a $100,000 house, but rather small for a $2 million mansion.
This is useful, actually, because it can be another tool to help you think about how much house you can afford. Thinking about monthly payments is useful, of course, but thinking about how much money you have set aside for your down payment — and comparing that to the total amount you want to borrow — can help, too.
Typically, the bare minimum you’d want to put down for your new home is 5%. So, for example, if you’re looking to buy a $200,000 home, you’ll want to have at least $10,000 to put down.
But, again, that’s the bare minimum. It’s far more common to see borrowers put down larger percentages. In fact, many homeowners will target a down payment of 20%. That’s a great number to target. At that threshold, your lender will likely give you a much more favorable loan. In our example above, you’d be putting down $40,000 for a $200,000 home.
What about non-standard loans?
The above advice refers to standard bank loans. But there are more… creative ways to buy a home, including other types of loans that don’t require traditional down payments. Many of these have certain requirements you need to meet in order to qualify, but if you do, they can be boons for people having trouble scraping together a downpayment. Here are a few examples:
- VA Loan: These loans are available to active-duty service members and their families. They’re backed by the Department of Veteran’s Affairs and typically require little or even no down payment.
- USDA Loan: Another loan program that exists for people who meet certain requirements comes from the US Department of Agriculture offers loans to people in rural and certain suburban areas. There are credit checks and other qualifications that you’ll need to consider, but these loans don’t require a down payment.
- FHA Loan: While a Federal Housing Assistance Loan does require a down payment, it’s typically a lot smaller than a bank would require. Your bank might require 10-20%, while an FHA loan might require 3.5%. That can make a huge difference and might be more manageable for you.
Get down with your down payment
There are some misconceptions out there about how much down payment for a house is necessary. You may hear that you need to put down 20%. While it’s a good idea to put that much down, it’s not set in stone. You may be able to put down less or you may qualify for a non-traditional loan.
In fact, if you get creative, you might be able to explore lots of ways that don’t require any down payment at all.
But, as always, do your research. See what options are best and most realistic for you. And don’t be afraid to wait a bit, too. Perhaps you’ll be in better shape to make the right down payment in a few months or a couple of years.
Deciding how much down payment for a house is worth it to you is just one of many important decisions you’ll need to make, and taking your time to consider your options is always a good idea.
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