Whether it’s nesting in a cozy craftsman home on a hillside or in a seaside abode, achieving your long-term goal of being a homeowner isn’t as far a stretch as it seems. And while saving for a sizable down payment for your dream digs seems like an elephant of a goal, with a little bit of planning it’s definitely doable.
Depending on your credit, while some lenders require a down payment of only 5%, and special government-backed loans such as the one from the Federal Housing Administration (FHA) require only 3.5% down, it definitely works to your advantage to save 20% for a down payment.
So why is 20% considered the magic number?
For starters, you avoid paying private mortgage insurance, or PMI, which is required if you’re putting less than 20% down on a home. PMI protects the lenders in case you end up needing to default, and it costs anywhere from .25% to 2% of your loan balance.
That being said, by putting down 20% up front, you’ll have a smaller monthly mortgage payment and might even manage paying off the mortgage early. And seriously, just how awesome would that be? By having less of the total price to pay off, you’ll have more money freed up to put toward other goals, or toward a home fund to take care of repairs and upgrades.
When to start saving
Naturally, the earlier you start on saving up for a down payment, the more time you’ll have to save up for that 20%. Poke around and see where you ultimately want to settle down and how much it will potentially cost. Besides the mortgage, you’ll want to factor in taxes, insurance, repairs, and closing costs. While you can’t predict the state of the housing market in a few years, you can get a jump on stashing away cash for it before you are on the hunt.
Starting out two to three years—if not earlier—before you plan on purchasing a home will give you plenty of time to save up. Having more time to stow away those hard-earned beans will give you enough breathing room to juggle your other financial goals. If you can swing it, try to find ways to cut back on your current expenses. Go for the big, easy wins first. Look into side hustling to bolster your savings.
The advantages of a large down payment
Putting down a large down payment creates a sort of ripple effect and lowers other costs of the home. If you have a larger down payment, you’ll also be paying less interest on the mortgage overall, which equates to significant savings. Having a larger down payment shows your creditworthiness and confidence as a borrower. This in turn will up your chances of getting approval for a loan. On top of that, it will most likely lower your interest rate, which will also help bring down your monthly payment and how much you’ll be paying on the home overall. So it’s pretty much a win-win situation.
The “penalties” of a small down payment
Besides having to pay for PMI, while lenders generally have lower requirements for minimum down payments, it’s a lot tougher to get approved for a mortgage with less money up front.
Plus, with a larger debt load, it’ll make it that more difficult to meet the Consumer Financial Protection Bureau’s (CFPB’s) “qualified mortgage” requirements, which state that homebuyers have a total monthly debt-to-income ratio no higher than 43%.
What this means is that your total debt (think car loans, student debt, credit card debt, and so forth) can’t be more than 43% of your income in a given month. So if you have a larger mortgage payment, it’ll be tougher to stay within that debt-to-income ratio. You’ll also have less wiggle room to take on any more debt in case you want to, say, take out a personal loan or car loan.
By getting a jump on saving up for a sizable down payment well before you’re on the hunt for an abode of your own, you’ll swiftly enter the new terrain of homeownership like a pro.
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