There are several programs out there that allow first time homebuyers to buy their home with as little as three to five percent down. It isn’t just cities like Boston or San Francisco where buying a home can seem out of reach. Home prices all across the country are climbing much faster than salary increases, so a smaller down payment might feel like your only option in order to reach your goal of home ownership.
But there are plenty of reasons to consider a larger down payment. While your personal financial situation will direct your decision, here are few reasons to postpone a home purchase until you can afford a 20% down payment.
1. Primary Mortgage Insurance: PMI is a payment lenders tack on that “guarantees” you make your monthly mortgage payment each month. In general, lenders want to see 20% in equity (the part that you actually own) before you don’t have to pay PMI anymore. Seriously, though, why pay more on something that suggests you might not be able to afford it?
2. Putting more money down means a lower monthly payment. Think about it: If you make a larger initial payment, you will have less to pay back. Likewise, if you make a smaller payment in the beginning, then you will have MORE to pay back. Don’t forget: over time that means more money going toward the cost of the loan, which is the interest rate, in addition to that monthly PMI. Let’s do the math:
Say you want to purchase a home for $400,000 and your interest rate is 4.2% on a 30-year mortgage.
A down payment of 10% is $40,000. The monthly payment is $1,777.
A down payment of 20% is $80,000. The monthly payment is $1,580.
The monthly difference is $197, nearly $2,400 per year and $30,000 over the life of the loan.
Count on paying PMI until you reach 20% which can tack on another $50-200 per month.
3. More equity means more protection in a down market: We cannot predict what markets will do, but we can help protect your assets and provide more choice and flexibility. Using the previous example, if the value of your home drops to $350,000 and your down payment was $80,000, your equity has now gone from 20% to nearly 23%. If you need to sell or refinance your home, you may qualify for a better rate because you are viewed by lenders as less risky. Same goes for reselling your home. If you need to relocate for a job or be closer to family, assuming your home sells, you will not owe as much on it and be able to cover the loan in the sale.
4. Access to a home equity loan and line of credit: Because you have equity in your home, you can borrow against yourself. Depending on your personal financial situation, tapping the equity in your home can be an alternative (again adding choice and flexibility) to taking out a personal loan. You may consider this route when renovating the kitchen or a bathroom, or even helping to pay for college costs. The rate may be more favorable, and generally, it’s a lot less paperwork.
Your personal financial goals and situation will determine how you move forward with the purchase of your first home. Be sure to explore all of the alternatives available to you and how they fit with your other financial objectives. You want your first home buying process to be a great one. The work you do now to prepare will be worth it.