May 7, 2019

Planning for a Down Payment

A smiling man shakes another hand as a smiling woman looks on beside him.

You’re ready to leave renting behind and take the steps needed to become a first-time homeowner. But, the idea of a large down payment seems overwhelming. Whether your goal is to put 5 percent or 20 percent down, planning for a down payment is one of the most important tasks you’ll need to complete on your path to home ownership.  

An ample down payment helps reduce your perceived risk by the lender and can allow you to secure more favorable interest rates and terms. Generally, the larger your down payment, the more money you’ll save over the life of the loan. Borrowers who put down at least 20 percent of the sales price can avoid private mortgage insurance (PMI), build instant equity, and lower their monthly mortgage payments.

While down payments in the double digits aren’t required for every homebuyer, it’s a smart move since a smaller mortgage also translates to interest savings. How? A smaller principal loan amount results in less interest paid for your new home. In addition, your monthly mortgage (principal and interest) is based on the sales price less the down payment.

EXAMPLE:*

$190,000 Sales Price

5% Down ($9,500)   versus    20% down ($38,000)

↓                                                  ↓

$180,500 Mortgage  versus    $152,000 Mortgage

Total finance charges (Assuming a 30 year, 5.7% fixed rate loan)

                                           ↓                                                  ↓

$196,646.03                                 $165,594.59

Monthly Payment (Principal and Interest on a 30 year, 5.7% fixed rate loan)

                                          ↓                                                  ↓

                                    $1,047.62                                $882.21

*See Hughes Fixed Rate Mortgage Calculator

But, where does the money for the down payment come from? The National Association of Realtors 2018 survey found that for 58 percent of homebuyers, it came from their savings. Planning is necessary to save for a substantial down payment. Use the following steps to help plan for a down payment.  

Know What You Need

When you have a savings target, it makes it easier to identify the actions needed to save for a down payment. While payment requirements vary by loan type, the strength of your credit score and other factors, establishing a savings goal is the first step. If you’re unsure of the amount needed for a down payment, examine homes in your price range and plan to save 20% of the asking price.

You might be eligible for government, city or state down payment assistance programs that cater to first-time homebuyers. These homebuyer assistance programs can help reduce the amount you need to save for a down payment. However, until you’re approved for such a program, plan on saving for the commonly recommended amount of 20 percent.

Locate Your Sources

Regardless of your eligibility for homebuyer assistance programs, there are other ways to obtain the funds needed for your down payment, such as:

  • Reducing expenses, e.g., selling your car to eliminate your car payment and using public transportation
  • Earning more income by working overtime, taking a second job or starting a side hustle
  • Borrowing from your retirement savings**
  • Accepting financial gifts from relatives, family, and friends
  • Downsizing now by moving in with family or friends, securing a smaller rental unit or finding a roommate. Save the difference, and you’ll see your down payment fund increase quickly.
  • Depositing financial windfalls (ex. an inheritance, tax refunds, rebates, etc.) directly into your down payment savings account instead of spending these funds on other purchases

**Subject to retirement plan borrowing limits, penalty fees, and repayment requirements

Save for a Down Payment

The key to saving for a down payment is to start early and deposit often. Consistent savings add up quickly. Create a separate account that earns interest. Savers aiming to help their money grow faster than normal should avoid basic savings accounts and choose money market savings accounts or certificate accounts. Unlike savings accounts, these alternatives require a minimum deposit, but in return pay higher dividends. This means your money grows faster.

Remember that a down payment is only one expense homebuyers will need to cover on their path to home ownership. Closing costs, moving expenses, and new furniture should also be factored into your savings plan. Your monthly budget will also need to be adjusted as you add the potential increase in expenses like homeowner association fees, homeowner’s insurance, and general home maintenance. The steps you take to plan for your down payment are more than an investment in your new home. They are an investment in your future.