Many aspiring homebuyers fear they will never be able to save up a 20 percent down payment. On a $500,000 house, for example, that’s $100,000 in cash. And when you must cover rent, other monthly expenses and possibly additional debt, saving that much money can seem like an impossible feat.
But the reality is that you don’t need to pay nearly that much down. A veteran can get a home loan with nothing down, and anyone who qualifies can get a mortgage with as little as 3.5 percent down – and sometimes even less.
But just because you can buy a home with a minimal down payment, should you?As with many financial situations, the short answer is: It depends.
If you don’t have a 20 percent down payment and you think it will take you years to reach that point, buying now may be a smart move.
“If you really want to buy a house in all other regards ... you’re going to be happy in the long run if you buy now,” says Casey Fleming, author of “The Loan Guide: How to Get the Best Possible Mortgage” and a mortgage professional in the San Francisco Bay Area. “Don’t wait unless there are other reasons to wait.”
According to the National Association of Realtors, the average down payment on a home in 2016 was 11 percent. For buyers under 35, it was just 8 percent. In fact, 16 percent of buyers under 35 put no money down and another 36 percent made down payments of less than 5 percent, according to NAR data.
The last major housing crash scared some people away from low down payments after many homeowners found themselves owing more than their homes were worth when values plummeted. But even a 20 percent down payment won’t protect you against a 50 percent drop in home values. In fact, if you lost your home to foreclosure or did a short sale, you may have lost less money if you made a small down payment.
“I do think I’m seeing a lot of conservatism now, especially among millennials, and I don’t think it’s serving them well,” Fleming says. “If buying a home is right for you, buy now with what you’ve got. You can always refinance later.”
Even after recent hikes from the Federal Reserve, interest rates are close to historic lows, a reason to buy now rather than later, if you are otherwise prepared to purchase a new home. Two years from now, both interest rates and home prices may be significantly higher, no matter how much you’ve saved.
Whether buying a home with a low down payment is a wise decision depends partly on your overall financial picture, including your other debts, your salary and your family obligations. Once you own a home, you’ll face expenses for repairs and maintenance. That means that spending every last cent on your down payment isn’t a good idea.
“I would be very leery if that 3.5 percent was all you can raise,” says Liz Weston, personal finance columnist and author. “You can wind up pretty deeply in debt if you don’t have the cash in hand.”
Many lenders require homeowners to have savings left after they buy – and for good reason.
“Owning is just a lot more expensive than people realize before they get into it,” Weston says. “It really pays to have some wiggle room.”
If you pay less down, your monthly payment will be higher and you may be forced to pay a higher interest rate.But for someone with a solid income and low debt, buying a home before you’ve saved up a 20 percent down payment can be a good choice.
“If you will have money left over, I think a smaller down payment may make sense,” Weston says. “It’s not a crime if you have to pay private mortgage insurance.”
Lenders usually require private mortgage insurance, or PMI, if you make a down payment of less than 20 percent. The insurance protects your lender, not you, in case you default on the loan. PMI can add $30 to $70 per month per $100,000 borrowed to your monthly payment, with the exact amount determined by your financial profile and your down payment amount.
Once your home equity reaches 20 percent, either because you’ve paid down the mortgage or through appreciation, you can ask your lender to remove the PMI if you have a conventional mortgage. That usually requires paying for an appraisal. If you have an Federal Housing Administration mortgage, you are stuck with the PMI for the life of the loan, though you can refinance into a loan without PMI once you’ve reached 80 percent equity, if you otherwise qualify.
“If you want to get rid of the mortgage insurance, it’s going to cost you a $500 appraisal fee and a lot of hassle,” Fleming says.
That makes a good case for putting the 20 percent down if you have it.
“I think you should put 20 percent down to avoid mortgage insurance because mortgage insurance is just money thrown away,” Fleming says.
Some lenders will offer a combination mortgage deal, such as an 80 percent first mortgage and a 10 or 15 percent separate second mortgage or line of credit. This means you would have two monthly payments, but it allows you to get a loan without PMI with a down payment of less than 20 percent. But those deals require more work from the lender, which means they may not offer that option if you don’t ask.
There are also those who argue that it makes sense to make the lowest possible down payment and invest the money you don’t use. While that sounds good, you’d need to get consistently high enough returns to cover the cost of PMI and your higher house payment.