How much home can you afford? Managing down payment costs

It's no secret that perhaps the biggest financial hurdle facing homebuyers is the down payment required by most mortgage lenders. Conventional down payments run as high as 20 percent of the home's sale price. For many, that is simply too much cash, and can seem like an impossible goal for which to save. Fortunately, there are several ways to reduce the down payment on a home, or at least reorganize it depending on the situation.

"The typical down payment on a home could total tens of thousands of dollars."

According to the latest data on housing prices in the U.S., the median sales price for a home is around $192,500, although this is expected to increase 3 percent by the end of 2017. That means U.S. homebuyers can expect to pay almost $40,000 in a cash down payment on a typical home. For residences in more expensive urban areas, this can be an even bigger burden. Saving enough cash to put 20 percent down on a mortgage is often cited as the largest impediment to prospective homebuyers, particularly younger, first-time buyers who may be saddled with student loans and thin wages.

Most common down payment reduction

While the 20 percent down payment is the ideal option in most home purchase situations, it's far from the most common. In fact, many mortgage borrowers end up putting much less than 20 percent down thanks to private mortgage insurance. As the Consumer Financial Protection Bureau explained, PMI is applied to a conventional loan to effectively reduce the down payment.

Of course, PMI does not mean borrowers simply are excused from paying these costs. PMI is most often applied to a borrower's monthly loan payments, in effect spreading out some of the down payment over the life of the loan. The exact costs and methods for determining your PMI premium will be detailed in the official Loan Estimate and Closing Disclosure that borrowers are required to sign before moving ahead with a mortgage.

Paying PMI tends to be more expensive than making a larger down payment upfront, but these slightly higher costs may not matter much if they are spread over a 15- or 30-year loan. In addition, borrowers can request to cancel PMI premiums once they have paid at least 80 percent of the loan's principle value. In addition to meeting this requirement, the homeowner needs to have a long history of on-time payments, and must prove (via a home appraisal) that the home hasn't declined significantly in value.

Down payment assistance programs

There are also a number of special loan programs that offer reduced down payments for certain borrowers. These mortgages may be limited to applicants with special circumstances, or may involve higher long-term costs.

  • FHA loans are the most well-known mortgages that offer low down payments, sometimes as little as 3.5 percent. These loans are designed for borrowers with lower incomes and subprime credit histories, so they won't cover very expensive houses. They also require PMI premiums that are generally harder to forgive than in the case of a conventional loan.
  • VA loans are guaranteed by the U.S. Department of Veterans Affairs and are intended for military service members and their families. These loans can be had for as little as zero percent down and no PMI, but borrowers and the home they wish to purchase must meet strict requirements.
  • USDA loans are for rural properties in an effort to stimulate local economies. USDA loans only apply to homes in certain areas, usually near agricultural centers. They are intended for lower income owners and offer zero percent down payments.
  • Some municipal governments and other organizations also offer down payment assistance for various types of borrowers, so buyers are encouraged to conduct thorough research to find out if this is an option.
mortgageCarefully weigh the benefits and costs of either reducing your down payment or securing a lower interest rate.

Choosing between a small or large down payment

As with any financial decision, there are two sides of the coin when it comes to the down payment on a home. Trulia outlined a few basic points to consider before making a decision either way.

Benefits of a bigger down payment

  • If you can save up the cash to afford a 20 percent down payment, you stand to save a lot from that point forward. Closing costs will be significantly reduced. PMI will be removed from the equation, allowing smaller monthly payments. Even the interest rate you pay on the outstanding loan balance will likely be lower. That could equate to thousands of dollars saved per year.
  • Putting money down on a loan isn't just like throwing cash in the dumpster - 20 percent down also equates to an instant 20 percent equity stake in your home. The more equity you have, the closer you are to fully owning the home and seeing a real return on your investment. More equity also allows borrowers to take out an equity line of credit if they need some extra cash down the road.

Additional advantages of a reduced down payment

Simply paying less upfront is just one of the potential upsides of reducing your down payment. But keep in mind, doing so may not be the most financially savvy move for every homebuyer.

  • If you feel certain that you won't be moving out within a few years, it might make more sense to pay the additional PMI to keep more cash on hand for emergencies. As Trulia noted, a home equity loan can make for a nice safety net, but still involves its own expensive fees and interest rates.
  • On the other hand, if you don't want to stay in the home for very long, the equity gained from a large down payment might not pay off when it's time to sell. If you're lucky enough to snag a home in an area where real estate prices are on the rise, you could still eke out a profit on a sale after only a few years. But again, this requires quite a bit of luck.

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