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Buying a Home. Downpayment Basics

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    Buying a Home. Downpayment Basics

    Buying a home: A few Basics to save up for a down payment

    This article is intended as a basic overview on saving up for a down payment on a primary residence. It does not cover all possible situations or scenarios and doesn’t deal with investment property strategies.

    Down Payment Basics

    First, you are probably going to need a downpayment. Buying a home with all cash is expensive and most lenders are going to require that a borrower produce a down payment in order to purchase a home. Your goal should be to put down 20%, but a lender may require less. With less than 20% down, you will probably need to pay Private Mortgage Insurance (PMI). You will also likely need to save up the money for your downpayment.

    Private Mortgage Insurance

    Most government backed and conventional loans will require PMI (private mortgage insurance.) If you put down less than 20%, then you will likely have to pay PMI. There are some conventional loans that will eliminate PMI, but the average home buyer won’t have access to this type of financing.

    If you have a government guaranteed loan, such as a Federal Housing Administration (FHA), Veterans Administration (VA) or United States Department of Agriculture (USDA), you can probably get access to a reduced down payment consideration. Some of these products such as USDA and VA loans have 0% down payment considerations. You can learn more about VA loans here:
    FHA loans have their own version of PMI called MIP. Down payments for FHA loans start at 3.5%. It is recommended, however, that you strive to put down 20% no matter what type of financing you are seeking for a home purchase.

    Paying PMI

    There are three main ways to pay PMI:
    • As a fee on your monthly statement. This is usually about .5% to 1% of the annual house paid monthly. This varies based on the down payment and the credit score.
    • Lender Paid PMI. Lender paid PMI is usually paid via a higher interest rate (typically .25%) for the life of your loan.
    • A one-time lump sum fee. In this case you’d pay something like 3% of the housing price instead of the monthly charges.
    Be advised that PMI does not go toward paying down the mortgage. It is simply a fee charged by the lender to manage the risk of holding your loan. This is why a 20% down payment is preferable.
    So, what options do you have? First and foremost, you can avoid PMI altogether if you have a 20% down payment. But, if you already have PMI, here are a few ways to eliminate it.

    Eliminating PMI

    Paying extra on a mortgage may not always be the best use of money, but paying enough to eliminate PMI is usually always a good financial move. To cancel PMI you need to write to your lender and request cancellation. The Homeowners Protection act gives you the right to request that your mortgage servicer cancel PMI when the principle balance of your mortgage falls below 80% of the original value of your home. In this case, the “original value” of your home means the contract sales price or the appraised value of your home, whichever is lower. By law, lenders must terminate PMI when the date of your original mortgage is scheduled to reach 78% of the original value of your home.

    Here are other important criteria you must meet if you want to cancel PMI.

    • The request needs to be in writing.
    • You must be current on your payments with a good payment history.
    • You may need to prove that you don’t have any second mortgages on the home.
    • You may also need to provide evidence that the value of your home has not declined below the original value.

    Down Payment Amount

    How much of a down payment is optimal? Typically, 20% is the ideal amount in order to have enough equity to avoid being under water and to avoid PMI on conventional loans. But, that may not be realistic for some people. The average down payment in 2017 was actually 6% or less.

    The exact amount that you should put down will depend on your situation, but you should try for 20%. A 20% down payment will often give you better financing options and a lower monthly payment. You most likely won’t get a better interest rate for down payments larger than 20%.

    In 2017 the average down payment was 6% or less, so there are plenty of conventional mortgages being written with a less than 20% down payment. Just remember, you may end up with a higher interest rate, and you will most likely be subject to PMI.

    Where do you get the money for your down payment?

    Ideally, the down payment should be your money. In other words, you should save up for it over time by setting X amount aside in a separate account each month/paycheck/etc. until you reach your goal. Obviously, this could take a long time. So, there are some other options.

    • You can sell other assets in order to acquire capital for your down payment. This can come from anything of value. Household items, a car, stocks and bonds, etc.
    • You can also speed up the savings process by being more frugal with the money that you currently have coming in. Couponing, reducing utility bills, shopping around for and/or renegotiating insurance, cell phone plans, cable, internet, and other recurring services, and brown bagging your lunch are all ways to reduce expenses and speed up the saving process.
    • Picking up extra work is a great way to boost income. Part time jobs in retail and the service industry are readily available and are usually flexible with peoples’ schedules and availability. If you have a hobby or are good at repairing things or have some other skill, then you may be able to monetize it and use it to earn extra income.
    • If you’re lucky, you may receive a gift from a relative. Usually, there is no tax on gifted money less than $50,000, but you may need to produce a letter proving that the money is in fact a gift and not a loan.
    • You may qualify for special government programs to assist in your home purchase. There are various tax breaks and grants available to home buyers, but a lot of them are regional and usually are tied to your income level. But, it doesn’t hurt to search and see if you qualify for anything.
    • Retirement accounts can be a source of money for a down payment, but it is highly recommended that you avoid doing this. But, this option is out there should you want to research it further.
    • There are lenders that will allow you to take out a second loan and use it as part of the down payment. This can eliminate PMI, but you will now be subject to paying back two loans. This option is also not recommended, but it may exist.

    Where do you keep your down payment?

    You will want to keep it someplace safe. In other words, don’t buy stocks or other higher risk assets with your down payment money. A money market account, a CD, or a regular savings account are all good options to keep your money safe and earn a little interest along the way.

    So, there are a few basics to buying a home and saving up for a down payment. If you have specific questions, leave a reply and we’ll try to answer.
    Last edited by james.hendrickson; 11-29-2017, 08:05 AM. Reason: Formatting