Saving enough money for a down payment is one of the biggest obstacles I see homebuyers facing each day. It’s easily the most common topic of conversation I have with my clients. It’s important for you to know how much of a down payment is right for you, how your down payment affects the interest rate, how your down payment and credit score are related, when you’re required to pay mortgage insurance and how it’s eliminated, and how you can get a better interest rate by being a first time home buyer. So first off, let me explain what a down payment is. So the down payment is the difference between the purchase price of a home and how much you’re borrowing for that home.
So I’m just gonna give you a simple example. So let’s say you’re buying a $400,000 property and you’re borrowing $300,000 Your down payment would be 400,000 minus 300,000. It’s the difference, which is $100,000. Now you don’t have to put that much money down on a property. The down payment can actually vary depending on the type of mortgage you’re getting and the price point of the property that you’re looking at.
If you’re a first time home buyer getting a mortgage, you can actually put as little as 3% down when you’re buying a property. So if you’re buying a $400,000 property putting 3% down, you actually only need $12,000 for that down payment. If you bought a home in the past, so you’re no longer a first time home buyer, but you are buying a home you plan to live in year round, you can put 5 percent down. So 5% of 400,000 in that case would be $20,000 Now, of course, there’s different price points, so that number is gonna change. But it gives you a general idea that the rule of 20% isn’t an actual rule.
So someone might have told you that on a conventional mortgage, you need to put 20% down. Well, that’s just not the case. Now it might be a requirement to qualify for the mortgage, but it’s certainly not a requirement in general. The guidelines allow for much lower down payments with conventional financing than you may have been told in the past. There are other types of mortgages that allow for even lower down payments, like a VA mortgage, where you don’t have to put any money down if you’re an eligible veteran or active duty military member or a USDA mortgage where you don’t have to put any money down and you can buy a property in a rural location.
Right? So there’s ways to buy properties with lower down payments, and that amount will vary depending on the cost of the property that you’re looking at. Now the down payment that’s right for you is really gonna depend on multiple things. Right? There’s no just set down payment.
It’s what are your plans with the property? What’s your time frame for buying? How lengthy do you propose on maintaining that property? What type of property are you buying? Because let’s just say you’re buying a condominium and not just a primary residence that’s a single family home.
Well, a condominium may require a larger down payment for multiple reasons. It may require a larger down payment because the condominium association has a minimum down payment they require within the community. Right? We see that sometimes where specific communities require that you put 20% down just to buy in that community or maybe on a condo review, which is something lenders have to perform if you’re buying a condo and obtaining financing. It doesn’t pass what’s known as a full condo review, and you have to look at an alternative limited review.
Well, limited condo reviews for a mortgage company, they’re gonna require larger down payments. So the down payment might be required at 25% in those cases. Right? But like I said, that’s really property specific. Another reason why your down payment can vary is your debt to income ratio, the amount of money you make each month compared to what your expenses are each month, including that new property.
Now if you wanna know more about debt to income ratio specifically, make sure to watch my post about how a debt to income ratio is actually calculated. But your down payment has an impact on your debt to income ratio because the less money you borrow, the lower your debt to income ratio is. So the less you’re borrowing typically means you’re putting a larger down payment or you’re getting over the threshold of needing mortgage insurance on your loan, which is 20% on down payment affected by your assets, meaning the amount of money you have available for the down payment. So maybe you’ve saved up some money or you have money that you plan to take out of a retirement account, right, which would be your savings, but you can actually access that for the purpose of buying a property. Or maybe you potentially have access to funds in the form of a gift from a relative who’s willing to help you out with your home purchase.
Depending on how much money you’ve available in the form of assets could also affect your down payment on the property. Your price range that you’re looking in also can affect that. Right? You might be planning to put down $40,000 Let’s just say that’s how much money you set aside for the down payment on a property. Well, 40,000 on a $200,000 property is 20%.
40,000 on a $400,000 property is 10%, which will change the terms of the loan that you’re obtaining. So when it comes to the down payment, you really want to know how much money as far as dollars you have set aside to use for that down payment and not necessarily a percentage that you plan on putting down. Now there are down payment assistance programs available, meaning that there are programs that will go toward the money for that down payment if you don’t have all the funds on your own. Or even if you do have the funds available on your own, you still might want to utilize a down payment assistance program because it will keep your own funds free and available to use for other things you want to do to that property and allow the down payment assistance program to cover the down payment portion of the funds that are needed for the home purchase. Now your long and short term goals, how long you plan to keep the loan or the property, are also extremely important when it comes to determining how much money you plan to put down because you might decide a lower down payment makes more sense for you in the short run because you might wanna sell the property after 3 or 4 years, and then you’d rather do other things with those funds, like invest them into other avenues that can return money on the investments rather than tying it up in your property, which is only accessible if you were to sell or refinance in the future.
Now how does the down payment affect the interest rate on your mortgage? This is important, and we get asked this all the time. If I put more money down, will it actually reduce my interest rate? Well, first off, it’s important to know that interest rates work in 5% tiers. And when I say that, what I mean is that there’s a tier of 90% to 95%, 85% to 89.9%, so on and so forth.
And that’s how your credit tiers work. You really don’t see a difference in the interest rate until you get to about 25% down. When you’re in the 20% to 5% down payment range, the rates are really going to be the same. What’s going to change is going to be the LLPA’s, what we as lenders call loan level price adjusters. So loan level price adjusters are actually what are determining your interest rate behind the scenes with any lender.
And if you’re getting a conventional mortgage, the loan level price adjusters are gonna be identical from lender to lender because they’re set by Fannie Mae and Freddie Mac, not by the lender themselves. So let me explain what low level price adjusters are. Just give you a general idea of how this works. So I wanna show you. Let’s just say you have a 780 credit score.
So with a 780 credit score, if you put 5% down, the loan level price adjuster is point 125, meaning it’s a cost of 0.125 percent on top of whatever the cost of the interest rate is, if any, that you’re gonna get with 5% down. If you put 20% down, same credit score of 780, the loan level price adjuster is 0.375. It’s actually gonna be higher at 20 percent down than it is at 5% down, and that’s because you have mortgage insurance when you put less than 20% down, which makes the loan less risky to the lender, and therefore the adjustments to the interest rate are slightly less. But at 20% down, I said it’s a loan level price adjuster of 0.375. So it’s actually gonna cost you 0.25 percent more in cost when you’re putting 25 20% down versus 5% down with a 780 credit score.
But as I said, the threshold to really see a big difference in the interest rates or the cost of the rates is that 25% down mark. 780 credit score with 25% down, the loan level price adjuster is 0. So there’s no adjustment made to the cost of the interest rate if you’re putting at least 25% down. You wanna keep that in mind when you’re determining how how much you put down on a property because if it’s between 5% and 15%, well, you might as well go with the 5%. If it’s between 20 and 25% and you have that additional 5% to put down, well, if you’re gonna save money on the cost of the interest rate, at that point, it actually might be in your best interest to go ahead and put the extra 5% down and save on that cost for the rate.
So how does your down payment relate to your credit score? Well, this is pretty simple. A lower credit score equals higher risk, which equals a higher interest rate. So a lower credit score is usually gonna be an indicator of someone who has poor credit usage or payment history, and therefore, that person with a lower credit score is not going to qualify for as good of an interest rate as someone who has a good payment history and a higher credit score. So if you have a low down payment and you combine that with a low credit score, well, it’s gonna result in a higher interest rate.
You wanna have a higher credit score typically if you’re gonna put a lower down payment so you’re not paying some crazy amount in interest for the mortgage. Now a lower credit score can be balanced out with a larger down payment. So allow me display you the way this works. So let’s compare 2 borrowers. Our first borrower, let’s say, has a 780 credit score, which is the highest possible tier when it comes to mortgage credit.
They’re buying a $400,000 property, putting down 80,000, which is 20%. Now, we talked about this earlier. The loan level price adjuster for that person is 0.37 5. Now let’s just say that you had a borrower with a 6.60 credit score buying a $400,000 property with 20% down, while their loan level price adjuster is 1.875. That’s a difference of 1 a half percent in cost for the interest rate alone.
Not even talking about their other closing costs, down payment, anything else pertaining to the purchase. Strictly the cost of the interest rate. So, just for having credit at a lower level, you’re going to be paying cash wise $4,800 more, which is 1.5 percent of the amount you’re borrowing, 320,000 dollars,000. So if I multiply 320,000 by 1.5%, if you decided you’re gonna pay this additional cost for having a lower credit score and getting that interest rate upfront, you’re actually coming out of pocket with an additional $48100 that you don’t pay if you have a better credit score, or you can opt to take an interest rate that’s 0.75% higher than if you had the better credit score, which is $150 per month more in your monthly payment. And if you kept the loan for 30 years, having that lower credit score is gonna cost you an extra $54,000 over the term of a 30 year mortgage.
So just think about that. It’s absolutely crazy that just by not being as good, I guess, at paying your bills or making your payments on time or really focusing on making sure those payments are going in on time and you’re not, you know, driving your balances up on credit cards over the limits, just by staying on top of your credit, in this scenario, you’d be saving $54,000 which is absolutely crazy. It’s more than 10% of what the cost of that home would have been just for having poor credit. Let’s talk about what happens if you’re buying a property and you’re putting more than 20% down or at least 20% down. Well, you don’t have to pay mortgage insurance.
But if you put less than 20% down, you’re required to pay something called mortgage insurance or PMI. This is required anytime you get a conventional mortgage with less than 20% down. And just like with mortgage interest rates, the price of mortgage insurance can vary based on things like your credit score and also the down payment. So those things are considered in determining what the cost of mortgage insurance actually is. Now let me give you an idea of how mortgage insurances determine what the cost is.
There are 6 main mortgage insurance providers in the United States. It’s MGIC, Radian, Essent, National, United Guaranty, and Genworth. And like I said, the cost of the mortgage insurance can vary based on the individual, but what you might not know is that the cost of mortgage insurance can actually vary from one company to the next. So, of these 6 companies, the cost of mortgage insurance for the same borrower, meaning same credit score, same down payment, same property, that cost could be different. The same way a mortgage interest rate could be different if you were to go from lender to lender when shopping for the best possible terms on your purchase.
So whatever lender you’re working with, you want to make sure that they’re running a comparison between these 6 mortgage insurance providers to see who’s going to be the least expensive for you because you can actually be getting a slightly higher mortgage interest rate from a mortgage lender. But if they’re getting you a higher cost of mortgage insurance monthly, that means your monthly payment could be higher even at the lower mortgage rate versus another lender who might be an eighth higher on the mortgage rate but saving you money on the cost of mortgage insurance monthly resulting in a lower monthly payment. So this is important to keep in mind. Let me give you an idea of how mortgage insurance is affected by credit score the same way your interest rate and cost of the rates affected by credit scores. So 2 borrowers, once again, let’s do a similar scenario.
Borrow 1 has a 780 credit score, $400,000 purchase price. They’re putting 5 percent down. And their mortgage insurance and this is a real number that I ran on a scenario. The mortgage insurance, you probably might be thinking in your head, oh, it’s 100 of dollars. I don’t want to pay mortgage.
Well, guess what? If you have 780 credit, you’re putting 5% down in this $400,000 home, the monthly mortgage insurance is only $60 but if you have 6.60 credit, right, the lower lower end of the credit tiers, $400,000 purchase, 5% down, the cost of that mortgage insurance is $3.10 per month. So $2.50 more per month just for having lower credit scores. Think about how crazy that is. That’s a lot of money.
It’s $3,000 per year more that you’re going to be paying for the same home just in mortgage insurance because you have poor credit. Now, let’s just say you are a first time buyer. Right? Well, a first time buyer might actually qualify for a lower interest rate, but they’re still gonna pay that same high cost for mortgage insurance. So you wanna keep this in mind regardless of how many homes you purchase and you’re going with a lower down payment.
Understand that the lower your credit that you have is, the higher you’re going to be paying each month for mortgage insurance. Now, how do you get rid of mortgage insurance? Right? It’s not on loan forever. At least on a conventional loan, it’s not.
So mortgage insurance is automatically eliminated once your loan balance equals 78 percent of the original value of the property, essentially what you paid for the property. It will fall off on its own. However, you can have it eliminated even sooner than that if you have an appraisal done and you believe you have at least 20% equity in the property and that appraisal shows that you do. Now, most mortgage insurance companies are going to require that you pay mortgage insurance for at least 2 years before they’ll let you eliminate it. However, there are scenarios where you can eliminate it much sooner.
Let’s just say you made improvements to the home after closing, such as you put a pool and you put an addition on the property. There can be multiple things that you can do to improve the property. If you’ve done something like that and that’s driven the value up, well, at that point, you don’t have to wait 2 years to address having the mortgage insurance removed. You can actually do it anytime that you feel you have at least 20% equity in the property. Now, let’s talk about how to get a better interest rate as a first time homebuyer.
So I mentioned that earlier on that first time homebuyers can get better interest rates on conventional mortgages than non first time homebuyers. Well, first, what is a first time homebuyer? A first time homebuyer is someone who’s not owned a primary residence, meaning a home you live in, within the last 36 months, so the last 3 years. So the reason the rates are better for first time homebuyers because in April of last year, 2023, those loan level price adjusters that I mentioned earlier on were completely removed if you’re a first time home buyer and have income that’s at or below 100 percent of the area median income for where you’re looking to purchase a property. So permit me provide you with an instance of ways this works.
So let’s go with that same scenario we looked at previously. A borrower with a 6 60 credit score, which we’ve now determined is on the lower end of credit when it comes to qualifying for a conventional mortgage. $400,000 purchase putting 20% down, so 80,000 down. First time homebuyer income at a 100% area median income, which, let’s just say, Broward County, for example, is $84,500. Now I’m talking about qualifying income.
Is if they if you have a borrower who’s an hourly employee and their hourly wage for their base pay is 84,500 or less, Maybe that person has overtime or bonus or or commission. If we don’t need that additional income and all we’re using is the 84,500 or less toward qualifying, that’s the number that’s being referenced here. The qualifying income has to be a 100% of the area median income or below. So this person has a 6 60 credit score. Because there’s no loan level price adjusters, they’re actually going to qualify for a significantly lower interest rate, and it’s actually going to save $54,000 versus the same borrower who’s not a first time homebuyer just because they’re able to obtain a lower interest rate without those loan level price adjusters we talked about.
So we’re talking about my original scenario, which was loan level price adjusters at 1 0.875% or having to pay 0.75% more in the interest rate, which we said is equal to $54,000 over 30 years. Just by being a first time home buyer and avoiding the loan level price adjusters, if you’re at a 100% area median income or below, you’re saving $54,000 on the home versus someone who’s not a first time home buyer or someone who has is a first time home buyer but has income above the 100% area mean income level. If you’re considering a home purchase and have questions about your specific scenario, leave a comment below and I’ll reply to 100% of the comments I receive. And if you found the information in this post helpful and wanna learn more about mortgages and the home buying process, make sure to bookmark this website.
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