Dear Egghead: I don’t have much cash set aside for a home down payment. Is it true that I’ll need to put 20 percent down in cash to qualify for a mortgage?
ANSWER: Twenty percent is a rule of thumb that many people believe is correct. But most consumers and lenders no longer believe that 20 percent is realistic, at least it’s not for many first-time homebuyers nowadays.
Having said that, if you can afford 20 percent down, you’ll reap some considerable advantages:
- No private mortgage insurance. PMI protects your lender in case you default on the mortgage. And PMI is not an insubstantial cost. It can range as much as $1.9 percent of the original loan amount per year. Here’s a PMI calculator that can tell you how much you’d pay. Thankfully PMI doesn’t last forever — when you’ve reached 20 equity on your loan, the PMI can be cancelled.
- Lower interest rates. Since you’re less of a risk to lenders if you put at least 20 percent down, you’ll get a lower interest rate, perhaps 1 percent to 1.5 percent lower. That would save you a fortune over the lifetime of the loan.
- Lower payments. Since you’re financing a smaller mortgage, your monthly payments will be lower.
- Your offer is stronger. All else being equal, a seller would look more favorably on your offer that specifies 20 percent down, compared to a similar offer with a lower down payment. The seller would be more confident because you’ve got more skin in the game, and are less likely to walk away from the transaction.
The disadvantages of a larger down payment are fairly obvious. You’ll have less cash handy for making repairs or upgrades. You won’t have that money available for other investments. And it may take you a long time to save up the money for a larger down payment in the first place, perhaps delaying your entry into the real estate market for many years.
How low can a down payment go? It can be zero if you qualify for a Veterans Administration loan or a USDA loan. Federal Housing Administration loans require only 3.5 percent down. Also, various government agencies have grants for first-time homebuyers. Check with a local lender.
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