Saving for Down Payment on Your First Home

Saving for a down payment on your first home will be an important part of creating wealth and building equity in your home.  Your home is usually the largest investment you make in a lifetime and so the purchase and financing aspect is extremely important.

A down payment for a home is used to minimize the risk of the mortgage generator, whether it would be a bank or a different financial institution.  They want you, the mortgagor, to place your hard earned money into the transaction so they are more confident you will make your payments on time and treat the property with respect, since your money is at stake as well.

The size of a down payment, typically, rages from 5-30%.  Fannie Mae and Freddie Mac loans require a minimum down payment of 5-10%.
Any level below 20% is required to have what is called mortgage insurance.  Mortgage insurance insures that if a person defaults on their obligations, then the mortgage insurance will cover their obligations.  These mortgage premiums are paid monthly and range anywhere from 1-2%.

To reduce your down payment you could turn to an FHA loan, which gives you the option of a lower down payment at 3.5%.  However, this will incur FHA mortgage insurance premium, which will cost you 1% of the value of your mortgage at signing and it will cost 0.85-0.90% paid on a monthly basis thereafter.   Also beware that, at times, other mortgage insurers will also charge a flat fee at the beginning of coverage which can range anywhere from 0.5-1.5% of the value of the mortgage.  This is a large sum so make sure you add it to the costs when you are calculating the purchase of your home.

If, however, you pay down more than 20% of the value of your home then you will not need mortgage insurance.  Aside from that, you will also receive a more favourable interest rate from the bank which will mean large savings on interest over the term of your mortgage.  This could save you tens of thousands of dollars over the term of your mortgage.

The essence of saving money is quite simple to understand: have more money in your pocket than you have going out of your pocket.  However, people get caught up in the daily activities and don’t realize how much they’re spending and where.  Creating a budget for your personal finances is an important step to locating potential saving areas that could increase your savings rate and help you put money away for your down payment.

Lastly, you can consider withdrawing up to $10,000 from your IRA, penalty-free.  Depending on how your IRA portfolio has been faring, this could be a good or bad option, and would have to be decided on an individual basis.  The trade-off would be discarding the potential increase in the IRA portfolio and the savings for your retirement in exchange for a lower interest rate and, possibly, no mortgage insurance.  You should calculate if this makes sense for you.  Even if it does, then make sure that the savings you retain from a higher down payment go straight back into your IRA so that this has ample funding to grow until the day you need it, when you retire.


by Peter S.
By InvestorGuide Staff

Copyrighted 2020. Content published with author's permission.

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