You may be surprised to learn that the home you’ve been dreaming about is within your reach with a lower down payment. The deposit required depends on the mortgage you choose.

More and more opportunities offer first-time buyers the chance to get into their homes for much less than the traditional 20% down payment. Using a borrowing power calculator helps you determine which type of loan and deposit amounts best suit your specific circumstances. Of course, there are benefits and drawbacks you’ll need to be aware of for each choice. 

Continue reading as we cover the details of how down payments affect your first home’s mortgage terms.

Down Payment Definition

When you sign a mortgage contract, the lender requires you to put forth an initial payment or deposit in a percentage amount related to the home’s asking price, typically starting at 5% and incrementing up to 20%. The rationale for this upfront commitment is that the lender gains confidence that you have the financial backing to see the loan through to completion without defaulting.

From your perspective as the buyer, you gain equity into the home as your down payment increases. If you elect to sell before the loan term ends, you stand to break even or perhaps book a gain, depending on the market.

Loan Classifications

Once you’ve used your borrowing power calculator to assess what kind of loan you can take out, you need to work out the right mortgage for you.

Fixed Rate Mortgage

A fixed-rate mortgage allows you to lock into the same interest rate for the duration of your loan. Terms range from 10 to 30 years. Borrowers who put down less than 20% of their principal may be required to take out private mortgage insurance (PMI). This cost is baked into your monthly loan payment and amounts to 1% of the annual loan balance.

Adjustable Rate Mortgage

An adjustable-rate mortgage (ARM) lets borrowers speculate on whether the market rates will increase in exchange for a lower up-front percentage for a duration specified in the contract. The deposit ranges from 3 to 20% and also requires PMI when your down payment is less than 20%.

The main advantage here is that you’ll enjoy a low interest rate for the initial “teaser” period of your contract, followed by a rate adjustment at predetermined intervals, which can be annual or every three to five years.

Other loan classifications include FHA and VA. A Federal Housing Administration (FHA) loan is insured by the US government, features down payments as low as 3.5%, and is intended for first-time buyers who don’t have ideal credit scores. Current US active-duty service members and veterans can take advantage of Veterans Affairs (VA) loans backed by the government, which offer low percentages or no down payments. 

More On Private Mortgage Insurance

As we briefly mentioned, Private Mortgage Insurance is a requirement for borrowers making a down payment of less than 20% of their home’s stated price. Lenders do not offer PMI directly to borrowers. Instead, they will arrange for PMI coverage by putting a provider in contact with the borrower.

The premise behind PMI is to protect lenders and mitigate the bank’s risk should the borrower fail to keep up with monthly payments or if the borrower outright defaults on the loan.

PMI helps borrowers to attain a loan with a smaller upfront deposit. But it also results in additional expenses tacked onto their monthly payments. Specific rules vary, but generally, borrowers can request to cancel PMI once their property equity meets or exceeds 20% of market value.

This equity increase could be due to the borrower increasing their monthly payment amounts or a market valuation increase. In either case, you can expect lenders to require a new appraisal of the home’s market value to be conducted before PMI cancellation.

Benefits Of Larger Deposits

While not always required, putting down a home loan deposit larger than 20% of your loan principal offers significant benefits if you can make it happen. You’ll pay less interest over the term of your loan and qualify for a lower rate. You’ll also save on PMI expenses, reducing your monthly payment commitment.

Credit Report Considerations

As you might expect, your personal credit history factors into the down payment equation. A high score demonstrates a history of timely payments, positioning you as a lower-risk borrower. Lenders might be more likely to offer you an attractive interest rate even if you opt for a smaller down payment with a good credit score.

Those with credit scores as modest as 500 may find lenders willing to extend a home loan. Still, you should anticipate higher interest rates and a more limited selection of loan options.

Get Sound Advice

Work with your trusted financial advisor before deciding on your first down payment. Once you’ve finalised your budget and determined your home requirements, it’s crucial to explore all available options. Whether it involves seeking a loan with a lower down payment requirement or extending your timeline to accumulate funds for a more substantial down payment, carefully considering these alternatives is a pivotal step in the decision-making process.

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All in all, there’s no magic rule for what your deposit should or needs to be. Of course there are guidelines in place, but as we’ve explained, there are many combinations to explore to find what is most suitable for your financial situation now and in the future. Having read this article, you’ll be better equipped to make the right decision – now go out and grab that dream home!