Down Payment Strategy – Which One is Right for You?

If you are like most new homebuyers then you have most likely heard the rule which says save your money until you have at least a 20% down payment before you buy a home. The logic behind that rule is solid. It proves that you’re wise and have the financial discipline and stability to save for long term goals.

You may not know that there are many loan programs out there that allow a much lower down payment. These smaller down payments can actually have benefits to them as well.

So which is best for you? 20% or less?

The 20% rule

One reason the 20% rule is so well known is because it is a preferred down payment amount from all lenders. When you have at least 20% to put down on a house you are lowering the risk for the lender. Lower risk for the lenders means that they have more favorable terms for you.

When you are talking about more favorable terms with a 20% down payment the first two things that people may think about is a better rate and no private mortgage insurance (PMI).

With a 20% down payment lenders consider you to be a lower risk than someone who has a much smaller down payment. They know that you have a lot of money invested in the deal and that you are more likely to pay your mortgage payments. Because you are in a lower risk category that means that lenders will offer to give you a lower interest rate than they will those who do not have 20% down. When your down payment is less than 20% lenders will often give you a higher interest rate knowing this allows them to make more money in the early years of your loan.

By being a lower risk customer lenders will also reward you by not requiring PMI. PMI stands for private mortgage insurance which helps protect the lenders if you were to default on your loan. PMI can range anywhere from 0.5% to 1% of your mortgage annually. On a $200,000 loan, for example, your PMI payment could be anywhere from $83 to $166 per month. That is a lot to put on top of your principal and interest.

A Smaller Down Payment

While there are many advantages to a larger down payment there are also many advantages to a smaller down payment. The first advantage is that you do not have as much of your money tied up in the house. If you were to encounter a situation in which you needed to sell quickly you wouldn’t have as much of your money tied up in a house that you are having trouble selling.

The second advantage is that you have more money in your bank account for other things like fixing or updating the house. Many people may have enough money to put 20% down, but they make the choice to only put 3-5% down instead. Having this money in a much more liquid investment than a house that may have troubles selling means you have easier access to your money. You might have an unexpected medical procedure that you must pay for or maybe you have decided that your business needs a little bit more of your own money invested into it in order to reach your goals.

Regardless, of which down payment method you plan to use you should at least look into both methods as a means of protecting yourself and the money that you have invested.

If you would like help learning more about down payments and the various loan programs that are out there please feel free to get in touch with me.