You’d be a homeowner right now if it weren’t for one thing: the down payment. Right? Even for those who have decent credit and make good money, the down payment is often the great homeownership killer.
For many others, who do have enough money set aside to make a substantial down payment, the question is: how much? Conventional wisdom—not to mention most of the banks and a good portion of homebuying and financial experts—will tell you that 20 percent is the standard bearer when it comes to down payments. But is it really necessary to put 20 percent down?
The short answer is: no.
Now for the long answer.
“Raising a 20 percent down payment isn’t an easy thing to do. Fortunately, you don’t have to. “It’s a myth that all homebuyers must have a 20 percent down payment to buy a home,” says Nancy Herrera-Siples, a Riverside, Calif., branch manager at Primary Residential Mortgage on U.S. News. “So why do you constantly hear that you need to put 20 percent down? Because if you don’t, it usually means you’ll have to shell out money for either private mortgage insurance or government insurance, which is usually financed by the Federal Housing Administration (FHA).”
And there’s another rub for those who are already struggling to come up with the minimum down payment: that extra couple of hundred dollars per month feels like a penalty. It’s not, of course—”Mortgage insurance protects the lender in case you can’t make your payments and the house is foreclosed on,” said U.S. News—but that money can make a significant difference for those who are stretching to buy a home.
Still, when your only option to buy is a low down payment, which can mean an FHA loan or one of the new low down payment loans from Freddie Mac and Fannie Mae—”At the end of 2014, the two government-backed companies announced plans to slash down payments from 5% to 3%,” said CNN—PMI might literally be a small price to pay. Especially if swelling rents are making homeownership look more and more promising. Remember that PMI does go away eventually when your loan balance is 80 percent or less of the home’s value. If you’re in an area where homes are rising in value, this could happen sooner than you think.
Still confused about the ins and outs of down payments? Here are a few reasons to go high…or low.
When to make a substantial down payment
• When you’re looking to keep your monthly payment as low as possible and have cash to spare.
• When you just can’t fathom paying PMI.
• When your goal is to buy a forever home and own it free and clear.
• When you are approaching retirement age and can envision a reverse mortgage sometime down the line.
• When you want to buy your house and pay it off as quickly as possible.
• When the rate is lower with a higher down payment. “The more you put down, the better position you are in for negotiating a lower interest rate with your lender,” said Credit.com. Plus, a “low down payment might affect other loan features, such as…the points, which are upfront interest charges,” said Banking My Way.
• If you’re worried about being under water. If the market should drop in your area, you run the risk of owing more than your home is worth.
When to go low
• When you don’t have the funds for a higher down payment and can’t earn or borrow them quickly enough.
• When the rate on your FHA or Fannie or Freddie loan is comparable to that you’d get with a higher down payment.
• When you need to escape a high-rent situation and the monthly payment on a house is lower than what you’re currently paying, even with the PMI factored in.
• When you’re confident your home will appreciate quickly, allowing you to refinance and get rid of PMI quickly.
• When your investments can’t be touched without a penalty or are returning better than the interest rate you’ll get on your home.
• If you have something better to do with the money. “If you bought a $400,000 home, 5% down would be $20,000, while 20% down would be $80,000—a whopping difference. An immediate need such as a college tuition payment would make the smaller down payment more appealing,” said Banking My Way.
• When you feel more secure setting money aside for emergencies instead of tying it all up in your house.