Buying A Home The Down Payment Myth
If your dream is buying a home, you are likely saving up, dollar by hard-earned dollar, until you have that magic number for your home down payment: 20% of your dream home’s total value. That’s what all the experts say, right? That’s a myth! For the average American household, 20% amounts to a significant number. Throw in closing costs, and you’ve got a small fortune to raise – and years to go until you reach your goal.
It’s great that you’re putting money away toward buying a home, which will likely be the largest purchase of your life, but there’s one huge mistake in your calculations: You don’t need to put down 20%. The 20% myth is an unfortunate leftover from the era after the housing crisis when access to credit tightened up out of necessity. Thankfully, times have changed, and since FHA loans started more than 80 years ago, mortgages have not required a 20% down payment.
While it’s true that a higher down payment means you’ll have a smaller monthly mortgage payment, there are lots of reasons why this isn’t always the best road to homeownership.
Let’s explore loan options that don’t require 20% down and take a more in-depth look at the pros and cons of making a smaller down payment.
Loan Options
If you’d like to go the route of government-backed loans, these are your options:
1. FHA Mortgage
This loan is aimed at helping first-time home buyers and requires as little as 3.5% down. If that number is too high, the down payment can be sourced from a financial gift or a Down Payment Assistance program.
2. VA Mortgage
VA mortgages are the most forgiving but are strictly for current and former military members. They require zero down, don’t require mortgage insurance, and allow for all closing costs to come from a seller concession or gift funds.
3. USDA Home Loan
These loans, backed by the United States Department of Agriculture, also require zero down, but eligibility is location-based. Qualifying homes need not need to be on farmlands, but they must be in sparsely populated areas. USDA loans are available in all 50 states and are offered by most lenders.
If you’d instead take out a conventional loan, though, you can choose from the following loan types:
1. 3% Down Mortgage
Many lenders will now grant mortgages with borrowers putting down as little as 3%. Some lenders, like Freddie Mac, even offer reduced mortgage insurance on these loans, with no income limits and no first-time buyer requirement.
2. 5% Down Mortgage
Many lenders allow you to put down just 5% of a home’s value. However, most insist that the house be the buyer’s primary residence and that the buyer has a FICO score of 680 or higher.
3. 10% Down Mortgage
Most lenders will allow you to take out a conventional loan with 10% down, even with a less-than-ideal credit score.
Bear in mind that each of these loans requires income eligibility. Additionally, putting less than 20% down means paying for PMI or private mortgage insurance. However, if you view your home as an asset, paying your PMI is like paying toward an investment. In fact, according to The Mortgage Reports, some homeowners have spent $8,100 in PMI over a decade, and their home’s value increased by $43,000. That’s a significant return on investment!
Why make a smaller payment?
If you’re thinking of waiting and saving until you have 20% to put down on a home, consider this: A RealtyTrac study found that, on average, it would take a homebuyer nearly 13 years to save for a 20% down payment. You could be building your equity in that time – and home prices may rise. Rates likely will as well.
Other benefits of putting down less than 20% include the following:
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Conserve cash:
You’ll have more money available to invest and save.
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Pay off debt:
Many lenders recommend using available cash to pay down credit card debt before purchasing a home. Credit card debt usually has a higher interest rate than mortgage debt – and it won’t net you a tax deduction.
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Improve your credit score:
Once you’ve paid off debt, expect to see your score spike. You’ll land a better mortgage rate this way, especially if your score tops 730.
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Remodel:
Few homes are in perfect condition as offered. You’ll likely want to change your new home before moving in. Having some cash on hand will allow you to do that.
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Build an emergency fund:
As a homeowner, having a well-stocked emergency fund is crucial. From here on, you’ll pay to fix any plumbing issues or leaky roofs.
Cons of smaller down payments
In all fairness, there are some drawbacks to making a lower down payment.
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Mortgage insurance:
A PMI payment is an extra monthly expense piled on your mortgage and property tax. As mentioned above, though, PMI can be a good investment.
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Potentially higher mortgage rates:
You can expect a higher mortgage rate if you take out a conventional loan and make a smaller down payment. However, if you’re taking out a government-backed loan, you’re guaranteed a lower mortgage rate despite a less-than-robust down payment.
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Less equity:
You’ll have less equity in your home with a smaller down payment. Of course, unless you plan to sell in the next few years, this shouldn’t have any tangible effect on your homeownership.
Of course, this doesn’t mean you should buy a home no matter how much or little you’ve got in your savings account. Before making this decision, be sure you can afford to own a home. Your monthly housing costs should be less than 28% of your monthly gross income.
Now that you know buying a home is the down payment myth, are you ready to buy your dream home? We’d love to help you out! Call, click, text, or stop by Elevate Credit Union today to learn about our fantastic mortgage rates. We’ll walk you through the closing!
