How to Choose the Right Down Payment for Your Home?

How to Choose the Right Down Payment for Your Home?

Buying a home requires a down payment unless you are paying all cash. Most people choose to take a mortgage loan, and a new journey begins.

FHA loans have a minimum requirement of a 3.5% down payment. Other conventional loans require 20% or more. There are 0% down payment programs. However, in this article, I want to discuss the pros and cons of making a high down payment.

Some people believe that a high down payment helps you along the way. Your submission is earning you equity in the house. On the contrast, you find opinions such as there are better uses of that money. You shouldn’t lock the funds into your home. It can be an ongoing discussion. My goal with this article is to list down the disadvantages and the benefits of making a high payment.

Purpose of a Down Payment

The lender is assuming a risk by lending you the discussed amount. The bank is at the risk if you default on the loan.

In this case, the initial deposit protects the bank. Statistics suggest that if you make a high payment, there are fewer chances that you’ll default on the loan. Let’s say; you’re unable to pay the remaining amount. Still, the equity allows the bank to sell the house and recoup their investment without trouble. The sole purpose of a down payment is to minimize the lender’s risk.

Pros of Making a High Down Payment

Favorable Interest Rates

Submitting over 20% makes you a less risky candidate. That’s why, a high down payment, can get you approved quickly. You can also qualify for a lower interest rate. While it’s true, that a high amount can help with mortgage approval, it doesn’t affect your interest rate. Your credit score has a comparatively higher impact on the interest rate and improving your credit score might prove to be a better choice.

Private Mortgage Insurance

You don’t have to pay for the PMI. Most lenders want to finance up to 80% of the asset’s value, and financing over that requires extra insurance. However, you can skip this additional payment.

Debt-to-Income Ratio

A high down payment results in reduced monthly installments that automatically translates into a reduced debt to income ratio. Mortgage approval requirements say that the monthly installment should not make up more than 33% of your income.

A small installment reduces the debt-to-income ratio, which will help you qualify for other loans.

Immediate Access to Equity

You are getting a home with built-in equity. You have paid a significant sum for the house. In case of an emergency, you can withdraw money that you paid other than the initial 20%. Over time, property prices tend to increase, and your investment also grows with time.

Cons of a High Down Payment

Delaying the purchase of your house

It can take years to save up thousands of dollars. If that’s the case, you’ll likely buy a home later. Whereas, a small down payment allows you to make the decision earlier than later.

Emergency Savings

You spend years saving for the house but exhausting your entire savings account for the home is not the right decision. If you’re planning to pay more for the house, have a savings account that can support you for at least 12 months.

How much you want to pay for the house? The answer is going to be an individual preference. My suggestion is to visualize the ideal scenario. In most cases, the perfect situation is to have easy monthly installments and a good enough savings account. After that, you can pay the remaining funds to the mortgage lender.

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