Buying a house is the biggest and most complex purchase most people ever make. It shouldn’t be done on a whim. Make sure you prepare. A year or more before your target for closing the deal, develop a plan that allows you to buy a home with confidence.
Use the preparation time to get your finances in order. Start by paying off credit card debt and saving money for a down payment. Building a down payment fund that’s appropriate for the house you want to buy may take a few years, but it’s worthwhile. The size of your down payment affects how much home you can afford and the interest rate you can negotiate for a home loan.
Typical down payments for houses range from 10% to 25% of the purchase price, but even borrowers with down payments of less than 5% can qualify for mortgages. With the modest terms that some lenders are now offering, the need for saving may not be obvious.
Why saving for a down payment is important
There are good reasons why saving for a significant down payment makes sound financial sense:
- You become a better credit risk. Making a large down payment increases your investment in your new home, which makes you a better credit risk for your lender because you have more at stake. Having more equity in the home may help you qualify for lower interest rates for this mortgage as well as for other loans you may eventually need, such as auto loans.
- You pay lower monthly payments. The less you borrow, the less you must repay and the lower your monthly mortgage payments will be. For example, if you put 20% down on a $304,500 home (the median price reported by the U.S. Census Bureau for October 20161) and a 30-year fixed rate mortgage for the balance at 3.874% interest, your monthly payment (principal plus interest) will be $1,145. But on the same mortgage with 10% down, your monthly payment increases to $1,289.
- You avoid PMI premiums. When your down payment is at least 20% of the purchase price of your new home, you aren’t required to buy private mortgage insurance (PMI). With PMI rates ranging from 0.5% to 1% of your loan, avoiding this expense can save you thousands of dollars per year. If your down payment is lower than 20%, you can cancel your PMI insurance once you have 20% equity in your home.
- You have an edge in bidding wars. When real estate deals fall through, it’s usually because buyers can’t get the financing they expected. Higher down payments indicate buyers have the resources to actually close the deal. So, when sellers are evaluating multiple buyers, those with higher down payments have a competitive edge.
Other benefits of planning for homeownership
While planning a big down payment is helpful in purchasing a home, it benefits you in other ways, too. By looking seriously at the costs associated with homeownership and the state of your own income and expenses, you are more likely to begin thinking about your financial goals and how to achieve them. Then, with a realistic assessment of your situation, you can take the steps necessary to find a house you can afford that also meets your needs.
Not all the benefits to planning ahead are financial either. Buying a home is a big commitment that makes more than most Americans nervous – 70%, according to one study2. Their reservations include the total expense of homeownership as well as the effects on other aspects of their lives such as free time and vacations. Deciding to save money for a home, therefore, can inspire you to reassess your finances, lifestyle expectations and even the significant relationships in your life.
Developing a plan to buy a home and saving for a down payment can help establish a pattern of savings and trigger conscious decisions about debt that will serve you well throughout your life. When the actual house-hunting process begins, you will be prepared and able to move quickly when you find the right house to call home.