Home Loan Deposit : How They Work and How Much to Pay
Saving for a home loan deposit is usually the first step towards buying a home. But how much do you need? Why do you need a deposit at all? These are the type of questions that may torment first home buyers. So, let’s take a look.
What is a Home Loan Deposit?
A home loan deposit is an upfront payment, often in cash, which covers a portion of the total purchase price when you’re buying a home. Also known as a house deposit or down payment, you have to pay it out of your pocket and not borrow it. House deposits are almost always a part of the home buying process, but there can be some exceptions. For example, some home loans don’t require deposits. However, sometimes it can be a good idea to put down a house deposit even when it’s not needed. When you pay a home loan deposit, it means you have some equity in the house, and you can borrow less money. This leads to reduced monthly payments and a lower amount of money spent on paying interest over the loan term while providing lenders some degree of security.
How Much is a Home Loan Deposit?
The size of your house deposit helps lenders determine the amount of money to lend you and the type of mortgage that is best suited to your needs. It is often left to you to decide how large of a deposit to make. Some believe the bigger the house deposit, the better, while others want to keep it as small as possible.
Generally, homebuyers make a house deposit of 5% to 20% of the total value of the home. The rest is covered through a mortgage loan by a bank or lender. Although there are disparate beliefs on how much a house deposit should be, you must always decide after evaluating the pros and cons yourself.
Pros of Bigger Home Loan Deposit
Making a large house deposit helps in reducing the amount you borrow. This is because a big initial payment means a smaller loan. Thus you have lower monthly payments and spend less in total interest costs in the long term. Some upsides of a big home loan deposit are:
You can secure a lower interest rate increase if you put down a large house deposit because your lenders see you as a lower-risk candidate for the loan. It can be an interest-free way to jump-start paying off your home loan.
With a home loan deposit of 20% or more, you can avoid private mortgage insurance (PMI) and additional fees when purchasing a home.
Lower Debt-to-Income (DTI):
A high home loan deposit means lower monthly payments, which in turn lowers your debt-to-income ratio. The DTI shows how much of your monthly income is spent on paying off debt. A lower DTI indicates more borrowing power in the future. Lenders look at your debt-to-income ratio to evaluate if you have enough income to meet your financial commitments. Lenders generally prefer to see a DTI of 45% or lower. Keeping your DTI manageable by borrowing less (by putting down more) can make you a more desirable candidate for potential lenders.
As you pay off your home loan, you build equity in your home. So, a larger home loan deposit gives you a headstart in building equity in your home which can be leveraged for a home equity loan or line of credit (HELOC).
Pros of Smaller Home Loan Deposit
Regardless of the pros of a bigger house deposit, a smaller house deposit has its appeal. The reasons why some prefer to keep their home loan deposit small are as follows:
20% of the purchase price of a house is no small amount and can take years for some to accumulate. And everyone cannot wait that long to get their dream house so they may opt for a smaller house deposit.
Paying too much house deposit can deplete your savings and leave your money tied up in something that might not be easy to sell. Challenging scenarios may arise as you move through life where you may need a significant amount of money, and one must always be prepared. Putting your long-term financial health at risk by putting too much into a house deposit is certainly not wise.
There might be other plans in your life that you might want to use your funds for, such as growing your business.
Home Loan Deposit Assistance Program
Your state may provide various programs to assist first home buyers, such as the First Home Owner Grant (FHOG). So, it’s a good idea to research such programs in your state. These programs offer assistance with a large sum of money that can be used as a house deposit and closing costs. You can also ask your lender or mortgage broker to learn more about such schemes.
Although a home loan deposit is a crucial part of your home buying journey, it is only a tiny part of the overall financial picture. Therefore, you have to keep the bigger financial picture in the foreground while deciding how much to pay for a home loan deposit. This way, you remain within your budget and keep from putting a financial strain on yourself while you venture into the property market.
Saving for a deposit requires patience, discipline, and effort. But the payoffs of having a home of your own are huge as well.
Start your home buying journey with Capkon by talking to one of our Nepali mortgage brokers today! Book an appointment and receive a complementary finance strategy session where we discuss plans specific to your situation.