When it comes to buying a home, the more money you can put into the purchase price, the less your home loan will cost. Why? Because you will pay less interest. This is true of any loan, regardless of how much you are borrowing, and for this reason, it is important to save as much as you can before making that big purchase.
The question is: How much should you save? That, and your resources, of course, will determine how long it will take you to reach your goal.
A down payment on a home or condo can cost potential buyers between 5% and 20% of the purchase price.
Different opinions on loans and advances
Many personal finance gurus believe that getting a loan for any reason, even to buy a home, is not a good idea. This is because the amount of money you will pay over the life of the loan makes the asset you bought too expensive. Others argue that responsible use of credit is healthy.
Whatever your opinion, even experts agree that the more money you can deposit, the more profitable the loan will be. And that means you should save as much as possible.
Take home mortgages. Although you can deposit as little as 3.5% with an FHA loan or 5% with some other loans, you will likely pay a higher interest rate because the lender sees you as a higher risk borrower. That means the cost of the loan is unnecessarily higher.
Let’s say you buy a $ 200,000 home with an interest rate of 4%; With a 30-year loan, you would pay more than $ 140,000 in interest alone. But most Americans can’t afford a home without a mortgage, and paying interest is only part of the deal. According to ATTOM data solutions, as of its Q3 2020 US Residential Home Mortgage Origination Report, “Lenders originated 1,050,624 residential purchase mortgages in Q3 2020.”
Any home mortgage that does not reach 20% of the loan-to-value level will have private mortgage insurance (PMI) added to the monthly payment. That means you will pay between .5% and 1% of the loan amount annually for this insurance. For this reason alone, as a general rule of thumb, it is better to put at least a 20% down payment for a mortgage.
Auto loans and advances
The same principle applies to auto loans. You don’t have to worry about PMI on a car loan, but cars depreciate quickly. If the loan spans many years, you run the risk that you owe more money on the loan than the car is worth.
Auto gap insurance can help against that risk, but you better not put yourself in that situation in the first place. That’s why experts recommend at least a 20% down payment on any auto loan. If you can’t afford such a large down payment on the car you want, consider looking for a cheaper model to keep the cost of the loan within your price range.
Ways to save for an advance
A 20% down payment on a car loan or home mortgage is a lot of cash, and for many households, not practical. Still, you should try to reach these levels. In the case of a car, the down payment does not necessarily have to be in cash. Dealers will often lower the price of a new car if you trade in your old car as part of the deal. Or you can sell your car privately to raise money.
The same goes for a mortgage. Selling your current home at a profit becomes the money you use for your down payment. Do not accept the first offer you receive if it is below market value. Better to wait a little longer and get a fair sale price so that your down payment is higher.
If you’ve barely saved anything, the harsh truth might be that you need to slow down and be patient before making that big purchase. Create a budget for yourself that allows you to save as much as you can each month. Also, take a look at your home and see what you can sell to raise money. You may have more value than you think tied to your belongings.
You may also consider taking a part-time job or doing freelance work to earn extra money and save it for your purchase. To get motivated, spend some time figuring out how much you could save over a year if you had a second job.
- Experts say that 20% is the ideal amount to deposit on a home or car.
- It is possible to buy a home without a 20% down payment, but you will be responsible for paying the PMI and interest in addition to your mortgage payment.
- Experts encourage prospective home buyers to save enough cash to cover a down payment.
- Sticking to a budget can help you save time for a down payment on a house or car.
The bottom line
One thing is for sure: If you really want to make a great purchase in a financially responsible way, radical action will be taken. Live as thin as possible and delay buying until you reach your financial goal.
Too many people buy before they are financially ready and create more stress and problems for themselves. Slow down, save as much as you can, and then make your dream purchase. You will be happy that you waited. (For related reading, see “Saving for a Down Payment: Where Should I Keep My Money?”)