For most first-time home buyers, saving enough money for a down payment is the biggest hurdle to owning a little piece of paradise. Traditionally, lenders have required a down payment of at least 20% of the home's purchase price. However, lenders will now accept less than that if the borrower takes out private mortgage insurance. (In the last few years, innovative programs have made it possible to put down anywhere from 0% to 3% of the value of a home and still qualify for a mortgage. We'll talk later about those special programs.)
Should you put down less than 20%? Well, if you've got the money, there are advantages to putting 20% down. For one thing, you immediately have substantial equity in your home. This may be important to you psychologically, and that counts. In addition, you'll avoid having to pay private mortgage insurance.
If you haven't got the money, here are some last-ditch ways you might find to scrape the down payment together.
Private Mortgage Insurance (PMI)
Private mortgage insurance protects a lender in the event that you default on the loan. Lenders generally require mortgage insurance on loans with low down payments because experience shows that a borrower with less than 20% invested in a house is more likely to default on a mortgage. You're a Fool and you're not going to do this, we know. But they don't know it yet.
Mortgage insurance also enables lenders to grant loans that would otherwise be considered too risky to be purchased by third-party investors like the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). The ability to have a market for the mortgages means that lenders can loan more money to people like you.
The good news about insurance is that you don't have to pay it forever. You can usually cancel it after you have at least 20% equity in the home. (Contact your loan servicer to find out the procedure for doing this.) Typically, you'll be required to get an appraisal on the property. This will cost money (a few hundred dollars) but could be worth it in the long run. If you'd like some tips on reducing your mortgage insurance, then naturally you should click on over to our Foolish calculator -- How can I reduce mortgage insurance costs? -- for some help.
How Much of a Down Payment Should You Make?
Your decision will be dictated by your financial condition, the loan you can get, and your preferences. If you're financially secure, you may want to go ahead and put down the 20%. On the other hand, you may figure that, putting down as little as possible , you'll have that much more to invest. Then, if you know what you're doing and have a sufficiently long time horizon, your money will be earning more for you than if you had tied it up in your home.