If you don't know the facts when it comes to homebuying, you could end up paying tens of thousands of dollars more than you have to.Selena Maranjian (TMFSelena) Jan 13, 2018 at 6:48AMThe
Home Down Payments 7 Myths Debunked
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Myth No. 1: You need to pay 20% down
Let's start with this common myth. You may actually be able to get a mortgage paying little to nothing down. If that appeals to you, look into VA loans or USDA Rural Development loans (which apply to lots of not-so-rural areas near cities), as they offer mortgages with $0 down payments. Conventional mortgages backed by Fannie Mae or Freddie Mac may allow you down payments of as little as 3% to 5%, while Federal Housing Administration (FHA) loans are available with only 3.5% down. These can mean the difference between buying a home and not being able to, but understand that you'll be starting out with little to no equity, and if the home's value falls, you'll owe more than it's worth.
Most people simply don't have to pay 20% down. Even if you're not taking advantage of some low-down-payment program, your lender will likely be fine with you paying a little or a lot less than 20% down -- but when less than 20% is paid, private mortgage insurance (PMI) is usually required. Thus, there can be a cost to paying less than 20%. You'll be paying interest not only on your mortgage but also on your PMI loan. Once your home equity passes 20%, you should be able to have your lender cancel the PMI.
Myth No. 2: There's no reason to pay more than 20% down
With all that talk about paying less than 20% down, is it worth paying more? It certainly can be. The more you put down, the less you borrow and therefore the lower your monthly payments will be and the less overall interest you'll pay. That concept is illustrated by the table below. It assumes that you're buying a $250,000 home with a 4.5% interest rate on your 30-year fixed-rate mortgage and that your mortgage payments don't include taxes or insurance:
Down Payment Amount
Down Payment Percentage
Total Interest Paid Over 30 Years
DATA SOURCE: BANKRATE.COM CALCULATOR.
It might be too much of a stretch for you to consider paying $100,000 down for a $250,000 home, but look at what a different situation you'd be in if you could: Your monthly mortgage payments would be $253 lower -- a 25% drop. That would certainly make your monthly budget easier to manage, leaving you more money to spend on living expenses or savings. Your total interest paid over the 30 years would also plunge by 25%, or more than $40,000. It's worth thinking about whether you want to and can save up a bigger down payment than 20%. (Note, of course, that there's an opportunity cost involved. Any funds you put toward your home save you a guaranteed 4.5% that you won't be paying in interest -- but invested elsewhere, they could grow by more than 4.5%, though that's not likely to be guaranteed, and your investments could far lag that.)
Myth No. 3: Down payment assistance programs are just for first homes
It's true that there are some assistance programs dedicated solely to first-time homebuyers, but not all of them are. In some cases, you can be considered a first-time home buyer even if you've bought one or more homes in the past -- as long as you have not been a homeowner for three or more years. You might start by looking into "97% loan-to-value" programs such as Fannie Mae's HomeReady program or Freddie Mac's Home Possible Advantage program.
Some regions in the country that are trying to encourage home ownership might have their own assistance programs to help get people into homes.
Myth No. 4: It's too late to get a good interest rate
Yes, interest rates have been rising lately. After the Fed funds rate, which influences mortgage rates and other interest rates, fell to 0.25% in December of 2008, it stayed there until December of 2015, when it was hiked to 0.5%. With one increase in 2016 and three in 2017, the rate was recently at 1.5%. That's still quite low, historically speaking, because the Fed Funds rate hit a whopping 20% several times in the early 1980s.
The highest mortgage interest rate was really high: In late 1981, the average interest rate for a 30-year fixed-rate loan hit 18.45%! The lowest mortgage interest rate was really low: In late 2012, average interest rates for a 30-year fixed-rate mortgage hit 3.31%, while rates for 15-year loans sank below 3%. More recently, 30-year fixed loans averaged 4.1%.
To appreciate what a difference your home loan's interest rate makes, check out the table below for monthly payments on a $200,000 30-year fixed-rate loan for a $250,000 home:
DATA SOURCE: BANKRATE.COM MORTGAGE CALCULATOR.
Clearly, there are still good deals to be had.
Myth No. 5: You can't use gifts or loans for your down payment
If you're assuming that you can't use cash from gifts or loans for your down payment, that's not necessarily true. Some lenders and some mortgage programs insist that you use your own money, but others are more flexible. In 2017, 16% of home buyers received financial help from family members or friends.
Myth No. 6: Lenders can help you figure out your down payment
If you're new to homebuying, it can be tempting to just rely on lenders to tell you how much house can you afford to buy and what kind of down payment you should make. Lenders can overestimate how much home you can buy -- and some might see it as in their interest to do so. After all, the more you borrow, the more interest you'll be paying.
For best results, read up on home buying and make your own decision. Crunch your own numbers to come up with a price range, and be sure to leave a big margin of error for unanticipated developments such as job losses, income reductions, or health crises. A conservative estimate that has you living well below your means will help you sleep at night and reach more financial goals, such as retirement savings. Buying a very expensive home may leave you stressed out and possibly unable to keep up with mortgage payments at some point.
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Myth No. 7: Credit scores don't matter much for down payments
Finally, don't ignore the role of your credit report and credit score. If your credit score is low, you'll likely be offered higher interest rates for a home loan that can make your monthly payments and total interest paid over the life of the loan much higher. In some cases, you may even have trouble securing a mortgage in the first place! Some lenders may require a higher down payment if your credit score is bad.
The table below reflects recent rates for someone borrowing $200,000 via a 30-year fixed-rate mortgage. Moving from one score group to another can save or lose you close to $10,000 or more -- so spend some time looking into how you might increase your credit score.
Total Interest Paid
DATA SOURCE: MYFICO.COM AS OF EARLY JANUARY 2018.
There are lots of myths and misconceptions surrounding down payments as well as the whole home-buying process itself. The more you learn about it, the more you should be able to save -- and when it comes to home buying, that can amount to tens of thousands of dollars in savings!
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