Your home may be the single most expensive purchase you ever make. For most folks, paying in cash isn’t an option. Most of us take out a mortgage loan to buy a house.
If you’re planning to borrow the money, how much do you need to buy that home? If you want to buy a new shirt, it’s easy to tell how much money you need. You check the price tag, check your bank account, and see if you can cover it. It’s harder to tell how much money you need to buy a house, but you still have to have a budget before you stop shopping. The 2 things you’ll need to consider are your down payment and how much you can borrow.
What Is A Down Payment?
A down payment is an initial payment toward the home. For example, you may want to purchase a home for $100,000. You could make a down payment of $20,000 and borrow the remaining $80,000 through a mortgage loan. Historically, banks have been reluctant to give out mortgage loans without a down payment. They want you to make a cash investment in the purchase of your home so that you’re less likely to back out of the loan. Your mortgage lender may require you to pay anywhere from 5%-25% of the purchase price as a down payment before giving you a mortgage loan.
You’ll need to talk to your lender about their down payment requirements. Certain lending programs, such as HomeReady, may have lower requirements than others. The amount required may also depend on your credit score.
How Much Down Payment Do You Need?
For a traditional, 30-year loan, most lenders will want you to put at least 20% down. However, you may be able to pay as little as 3.5% down through certain programs. If you’re buying a home for $100,000, that’s the difference between $20,000 and $3,500.
Of course, it’s never quite that easy. If you put up less than 20%, your lender will see you as a bigger risk. You’ll have to pay for mortgage insurance every month. If you can make a full down payment, you’ll benefit from paying lower upfront fees and having lower payments every month. In part, that’s because you’re borrowing less money. In part, it’s because you don’t have to pay the insurance.
In addition, offering a larger down payment can get you a lower interest rate for the life of the loan. You’ll pay significantly less overall with a larger down payment because you’re paying a lower rate on a smaller amount.
For example, let’s go back to that $100,000 house. If you pay $20,000 up front, you’ll borrow $80,000 through a mortgage loan at 4.5%. Over the life of that loan, you’ll pay just over $400 per month. That works out to about $66,000 in interest overall. The total cost, then, is $166,000.
Now, say you put down just $3,000. You have to borrow $97,000 and you’ll have a higher interest rate – say 5%. Your monthly bill would be about $520 and you’d pay over $90,000 in interest over the course of the loan. In addition, you’ll have to pay extra every month for mortgage insurance – about $90 per month in this case. That’s an extra $32,000 total, for an overall cost of $222,000 for the home.
How Much Can I Borrow?
So, the first step in figuring out how much money you need to buy a house is figuring out how much cash you have access to for a down payment. The second part isn’t a question of how much money you have, but how much you can borrow. That depends in large part on how much money you make.
The size of down payment you can make will determine the maximum amount of money you might think about borrowing. If you have $40,000 to put down, for example, you might consider borrowing up to $160,000 and making a 20% down payment.
However, that’s not necessarily the right amount to borrow. You’ll first need to consider how much you can afford to pay every month. That means taking a good look at your budget and choosing an amount you’re confident you can cover. Then, you’ll have to figure out how much of a loan that monthly payment translates into given your financial circumstances.
Let’s go back to our example above. If you have $20,000 for a down payment, can afford $400 per month in mortgage payments, and qualify for a 4.5% interest rate, you can comfortably borrow $80,000. If you qualify for a 5% interest rate, however, the monthly payments on a loan of $80,000 will be $430 – that’s over your budget.
Finally, the bank may only be willing to lend you a certain amount based on your credit history and its appraisal of the house. You’ll have to work with a lender to determine what interest rate you qualify for and what the bank is willing to lend you.
The Bottom Line
When you’re getting ready to buy a home, you need to consider both your down payment and your monthly mortgage payments. One is an issue of cash on hand while the other is an issue of your income and your credit. It’s complicated – there are a lot of moving parts and a lot of different factors that go into it. At the end of the day, you need enough of a down payment and enough of a mortgage loan to cover the cost of the home you want.
If you need help with your mortgage, the Mortgage Warriors are standing by. Contact us today for a free consultation to learn what we can do for you.