Buying a Home: Reasons You Should Start Saving for a Healthy Downpayment

November 1, 2015

Buying a home via a mortgage has become relatively standard practice, with one of the first steps in the process being offering a downpayment to a lender when applying for the mortgage loan. In the past, a downpayment as low as 10 percent was acceptable, but no more. Today, most lenders want to get at least 20 percent, looking even more favorably on applicants who can give even more. They benefit from getting more money upfront, but you reap rewards from providing a larger downpayment, too.

Big Downpayment, Big Gains

When you apply for any type of loan, including a mortgage, the lender considers whether or not there is a risk you won’t pay back what you borrow. In this context, it looks for evidence you are capable of saving, the rationale being that a person who is able to save has a basic amount of control over their spending and general finances, and that an individual with that control probably won’t miss payments or default on the loan. You thus stand a greater chance of getting your mortgage application approved right out of the gate, especially if you can pair the larger downpayment with a stellar credit rating.

 

Even though amassing a larger downpayment requires financial discipline, handing a bigger sum to your lender can end up putting money back in your pocket. The more you can provide upfront, the more likely it is that you’ll get a better rate of interest. This benefit has to do with the fact that the larger downpayment lowers your loan-to-value (LTV) ratio, which compares how much you’re borrowing to how much the home is worth. The higher your LTV, the more equity you have in the property, and lenders translate this to mean you’re not as likely to default. Even if your interest rate ends up not being spectacular, you’ll still save simply because the big downpayment forces the lender to calculate interest on a smaller loan.

 

When you’re not able to put a lot of money down on a house, most lenders require that you take out private mortgage insurance (PMI). This type of coverage is beneficial in that it gives the lender protection in the event you can’t pay what you owe, but it’s negative for you because you have to spend extra money on the premiums. If you can provide a downpayment worth 20 percent or more of the value of the home, the lender likely will see you as presenting less of a risk and waive the PMI requirement. You’ll be able to put the money you save toward other expenses or, alternately, use it to pay the mortgage off sooner.

Another factor to consider with downpayments is negative equity, which essentially means the value of your home is less than what you owe on it. You might get drawn into negative equity because the property presents unforeseen expenses down the road and acquires more liabilities, but it also can happen when general home values take a plunge. The more you offer the lender at the start, the less likely it is that you’ll end up “upside down” on your loan.

 

How to Put Money Aside Starting Now

 Despite how daunting a larger downpayment can seem initially, getting started in saving is not difficult. Start out by making sure you’ve thoroughly compared your lending options. Some lenders, for instance, are more willing to work with individuals with lower credit scores or provide lower-than-average interest rates–check here for more information on finding the mortgage that’s right for you. Be realistic about what you can afford both now and potentially down the road, and give yourself a specific downpayment amount to work for. Then rework your budget to keep you on pace with your goal. If you can, create as many income streams as you can to reduce the amount of time necessary to save the downpayment. Low-risk investing, working multiple jobs, renting out what you own or even creating websites with revenue-generating options all are examples of possible streams.

 

And Finally

It is certainly possible to buy a home with a small downpayment. The more money you can give your lender at the start, however, the more likely it is that the lender will see you as presenting a low risk of late payments and default. That can mean easier approval, lower interest rates and other financial benefits, such as the waiver of PMI. Saving the downpayment doesn’t have to be challenging–be smart and start putting money for your dream home aside today!

Hudson Le Messurier earns a living in finance and likes to take the opportunity to share his tips and ideas with an online audience. He writes regularly for several consumer finance and lifestyle websites.

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