How big should your down payment be when you buy a home? This is a common question buyers have when they start thinking about house hunting and mortgages. Many people wonder how they can best split up the cost of buying a home between their mortgage and their down payment size. Do you have a choice, and does it make a difference?
Your down payment size can have a big impact on your future mortgage payments. Before you think about that, though, you need to consider your credit score. Credit scores can help determine what your down payment needs to be. You can’t decide much else until you know where your credit score stands and what that means for your down payment. How are these two subjects related, you ask?
Understanding your credit score
Several factors determine your credit score. Most obvious is how you handle the payments you owe – many people associate their payment history with their credit score. Borrowers who have consistently made payments on time and paid more than just the minimum will typically have higher credit scores. Missed or late payments can harm your score, depending on how much you owe and how late the payments are. The age of your credit cards or lines of credit can also affect your score. Lenders want to know you have a good history of making payments, meaning older accounts have an advantage over newer ones with less use.
According to Equifax, a score of 670 is considered “good.” Scores above 670 are ranked even more highly, while scores below 670 enter the lower levels. Every lender will have different criteria for what they consider a good credit score, but this is a general baseline of what your score might mean.
Understanding your down payment
You might already have a good understanding of what down payments are, but here’s a quick refresher. A down payment is the amount of money you contribute to your new home upfront. The remaining balance is paid through your mortgage payments. The higher your down payment, the smaller your mortgage, meaning you have to borrow less from your lender. Generally, this results in paying less interest over time, since your mortgage balance may be smaller. You can read more about down payments here.
How do the two relate?
So, how does your credit score have anything to do with your down payment? A lender needs to determine your risk level before they agree to give you a loan. This means they have to figure out how capable you are of making payments on time, and in turn, being a secure investment for them. If your credit score is on the lower side, it implies you may have had troubles with credit and finances in the past. Whether this is because of missed payments or insufficient data, a lender might look at your credit score and decide you’re a higher risk.
If a lender decides you’d be less likely to make your mortgage payments on time, that doesn’t mean they won’t give you a loan. However, it will mean they’ll require a larger down payment from you to prove you can afford your home. Often, they will ask for a 20 per cent down payment. You will likely encounter higher interest rates to help protect the lender in case of a default.
Should you always put 20 per cent down?
Higher credit scores look more attractive to lenders, so they will require a smaller down payment size from you because they have more trust in your financial security. The minimum down payment can be as low as five per cent. However, many buyers choose to aim for a 20 per cent down payment to avoid default insurance. For one thing, a bigger down payment means securing a smaller mortgage. Since you’re borrowing less from the lender, this will enable you to pay less interest over time.
A down payment of less than 20 per cent always requires mortgage default insurance. This is insurance to protect the lender in case you can’t make your mortgage payments. If you can put down 20 per cent, it’s a bigger expense up front, but it lets you avoid the cost of default insurance.
Is there ever a time when a smaller down payment size is a good idea? If you plan to enter the market as soon as possible, a smaller down payment takes less time to save up. This means you might be able to buy a home sooner, which can be a good idea in today’s busy market. Since housing prices keep increasing as supply dwindles, it might be worth getting into the market sooner with a smaller down payment.
Speak to a broker!
Your credit score and down payment size have a big impact on your home buying abilities. Don’t make any decisions before consulting me! As a broker, I can walk you through your credit score and how it impacts your eligibility for different down payments and mortgage products. I can also advise you on what a good down payment size might be for you. This is unique to every buyer as it depends on your timeline and housing prices, so be sure to contact me.
If you’re looking to buy a home in this competitive market and need guidance with your down payment, get in touch with me here!