All Main Aspects about a Down Payment
A down payment on a mortgage is a sum of money that you pay to the seller; the bank loans you the rest. Although it is possible to purchase a home with as little as 5% down for homes worth $1 million or less, 20% down is the conventional amount necessary for getting the best possible interest rates.
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Determining the Amount to Save
Everyone, regardless of his or her credit situation, should strive to save 20% of the total value of the home he or she wants to purchase. As such, if you want to buy a home that is worth $200,000, you should work to save about $40,000 on your own before asking the bank for a loan. This way, you show the bank that you are capable of saving funds and you reduce that financier's risk in lending to you. Whether or not you are able to save the 20% may affect whether you have a conventional or a high ratio mortgage – or if you qualify for a mortgage at all, depending on your credit. Those with bad credit should always save the full 20% (if not more) in order to get the best interest rates over the terms of their loans.
Conventional vs. High Ratio Mortgages
Those who save 20% or more of the value of the home have conventional mortgages. The difference between the two is that a third party must insure a high ratio mortgage, and the homeowner may need to pay an insurance premium. This insurance premium is not for the home itself; rather, it acts as a guarantee to the lender that they will receive their money if you default on your payments. Because of the insurance premium, your monthly payments may be higher than with a conventional mortgage. What's more, failure to save the 20% may also result in a higher interest rate, regardless of your credit situation.
If you must pay an insurance premium on a high ratio mortgage, there are a few ways to do so. Depending on the amount you are borrowing and the precise amount of your down payment, these premiums range from 0.5% to 2.7%. Most buyers opt to have these premiums figured into their monthly payments, but there is also an option to add the lump sum to the end of the mortgage and pay the premiums in full before taking ownership. Just like the mortgage itself, the insurance premiums are contractual and you must pay them before you can take over the ownership of the home.
As you can see, the size of your down payment shapes your mortgage as a whole. In the initial stages, it determines whether you even qualify for the mortgage, particularly if you have less-than-perfect credit. It also determines the size of your monthly payments, your interest rates, and insurance premium amounts. For the best possible outcome, work to save at least 20% of the home's value as a down payment before asking for a loan.