The biggest hurdle aspiring homebuyers face is saving enough for a down payment. It takes time and money, but at what point have you saved enough?
The 20 Percent Rule … Was Made to be Broken
The rule of thumb for down payments has traditionally been 20 percent of a home’s purchase price. It’s a lender thing. Essentially, the larger the down payment, the easier it is for a lender to say “yes.”
The reason is simple: The more money you have at risk in the home, the less of a risk you are to the mortgage holder. In other words, you have more skin in the game. At 20 percent, you have a lot to lose. On a $250,000 home, for example, that would amount to $50,000.
Get in With Less Down
Twenty percent down is not viable amount for many first-time homebuyers. This is particularly true for those who live in markets with high home prices and high rents (which makes saving much more difficult). For instance, as of June 2018, the median home price in California was $600,000. Twenty percent of this is $120,000. With a median income of $64,000 in the state, how is a first-time homebuyer supposed to save almost twice their annual income?
Today there are options available for buyers making a smaller down payment and, because of historically low interest rates and rising housing prices, getting into a home sooner rather than later is often the more prudent move. There are a number of federal, state, and local programs aimed at first-time homebuyers that allow mortgages with as little as 3 percent down—or even nothing down for many VA loan options.
In most cases, you will be required to pay private mortgage interest (PMI), which protects your lender, who is taking on a greater debt burden. However, you will begin accruing equity immediately. Once you reach that 20% loan-to-value threshold, you can have PMI removed or refinance to have it removed, depending on your loan program’s guidelines.
The insurance premium varies but typically runs between 0.5 percent and 1.0 percent of the loan balance, depending on the strength of your credit score, and some of the low down payment programs waive PMI under certain circumstances.
Rising Rents, Rising Costs
If you are trying to save for a down payment while rents are rising at historic rates, it can feel like swimming upstream. And if you’re not saving at a rate that mirrors the housing price increases, you could be going backward. For instance, if the home you’re saving for is $350,000 today but was $320,000 a year ago, your 4% down payment has increased $1,200. So you need to save more now to put the same percentage down.
Knowing what works best for you and your situation is the key factor in deciding how much money to put down. Your Loan Officer can talk you through the different options available and crunch the numbers to help you make the most of your savings and get you moving toward your homeownership goals.