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What is the Right Amount for a Down Payment?

If you were considering starting a business and had the option of either partnering with a friend or a co-worker, what criteria would you use to make your selection? Noting that starting a new business is risky—5 in 10 fail during the first 5 years of opening[1]—selecting the right partner could be the difference between success and failure. One of the key criteria that I use to make this type of decision is determining “how much skin they have in the game” or their level of commitment. The amount of money and time someone is willing to invest in a business speaks volumes about their confidence in achieving the goal.

Similarly, mortgage lenders are careful in their selection and use various assessments to identify the risk level of a loan. One computation they may use is the loan-to-value (LTV) ratio which compares the amount of the mortgage to the appraised value of the property. If a home appraises for $200,000 and the buyer has a down payment of $10,000, then the LTV is 95% ($10,000/$200,000). Typically, high LTV values are considered to be riskier loans and therefore the lender may choose not to extend the loan to you or charge a higher interest rate to compensate for the risk of possible default. In addition to higher interest rates, they may also charge an additional monthly fee known as mortgage insurance, until the LTV reaches 80%. Mortgage insurance is in place to cover the lender if the borrower defaults on the loan. This fee can add anywhere from .5% to 2% to the loan amount annually. Consequently, lower down payments equate to higher costs for the future homeowner.

 

Confident Home Buyer Tool Kit Tips:

  • Paying cash for a home is the most ideal scenario, but this may be unrealistic for many buyers who desire to become a homeowner as quickly as possible

  • At a minimum, lenders and loan types require a down payment of at least 3% of the home’s appraised value.

  • Contributing 20% for a down payment will save you the most money in interest and fees.

  • There are also some loan types that allow for 100% financing (no down payment), such as USDA or VA loans, but you and your desired home must meet certain requirements to qualify for these loans.

  • Use Step 5: Estimate Home Much Home You Can Afford in the Confident Home Buyer Tool Kit to see the impact that varying interest rates and down payments will have on your overall cost. Membership is free!

 

Paying cash for a home is the most ideal scenario, but this may be unrealistic for many buyers who desire to become a homeowner as quickly as possible. A recent study[2] by the National Association of REALTORS® revealed that over 30% of buyers, between the ages of 22 and 29, rated saving for a down payment as one of the hardest steps of the home-buying process. Options for assistance such as receiving gifts from parents or Down Payment Assistance programs should be explored if this step becomes too challenging. Nationally, there are over 2000 Down Payment Assistance programs, with 94 of them available in Georgia. If you are considering a Down Payment Assistance program, be sure you understand the details before committing.

At a minimum, lenders and loan types require a down payment of at least 3% of the home’s appraised value. Lenders typically offer loan options in 5% increments and will determine loan costs and interest rates to charge you. For example, if you have 9% saved for a down payment, consider saving a bit more to get to 10% in order to take advantage of the lower cost at that level. Contributing 20% for a down payment will save you the most money in interest and fees. There are also some loan types that allow for 100% financing (no down payment), such as USDA or VA loans, but you and your desired home must meet certain requirements to qualify for these loans. A good loan officer will be able to direct you to the best loan to fit your circumstances.

Saving for a down payment can take time and sacrifice but the investment reduces the risk for the lender and saves the borrower money in interest and fees. As a part of Step 5: Estimate Home Much Home You Can Afford in the Confident Home Buyer Tool Kit, you will be able to run multiple scenarios to see the impact that varying interest rates and down payments will have on your overall cost. Be sure to complete Step 3: Understand your Finances before going to this step, as some of the data you generate from Step 3 will be required for Step 5.


 

Denise Johnson, MBA, REALTOR®, is often referred to as a "Data Nerd" by family and friends and has a gift for seeing the important facts of a situation. She aims to fit all the pieces of the jigsaw puzzle together into a complete picture, making it easier for herself or anyone she counsels to make sound and rapid decisions.


After 10+ years of working for multiple Fortune 500 and 1000 companies across Logistics, Finance and Marketing, Denise made the leap into the Real Estate Industry hoping to help others achieve their homeownership desires. She can remember purchasing her first home at the age of 23, and it being both a time of joy and stress because she didn't fully understand the process and the implications of owning a home. Since then, she has owned and sold multiple personal properties, including selling an investment home that turned from a Rehab to a New Construction project in 2020. She has a desire to share all that she has learned and continues to learn with future customers to tip the scales towards a joyous homeownership and home-selling experience.

When she is not busy finding solutions in business, she loves large get-togethers with friends and family, international travel adventures with her hubby, and growing her passion for gardening and cooking healthy recipes.

 

[1]U.S. Bureau of Labor Statistics. Entrepreneurship and the U.S. Economy. Link to Report [2] Copyright ©2020 “2020 Home Buyers and Sellers Generational Trends Report.” NATIONAL ASSOCIATION OF REALTORS®. All rights reserved. Reprinted with permission. March, 2020, Link to Study

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