The minimum down payment on an FHA loan is 3.5 percent, which makes it a popular choice among those who do not have the funds for a large down payment (also those who do not meet the higher credit score requirements for other types of loans). And that is not even the lowest you can go. Some loans require only three percent down, and if you are a veteran or are buying a home in a rural area, you may be able to buy a home for nothing down. But should you go that low just because you can, or are you better off making a larger down payment? Here is break-down:
The case for a 20 percent down payment – There are several advantages to putting down 20 percent when buying a home, like:
Since the bank will generally consider you a lower risk because of your large down payment, you may be able to get a lower interest rate than you would with other types of loans—as long as you have the credit score to support it.
You will have built-in equity as soon as you move in.
You can avoid paying private mortgage insurance (PMI).
It is that last part that drives many people to strive for that 20 percent down payment since PMI can add several hundred dollars to a new homeowner’s monthly payment, and it can be hard to get rid of it.
But is that a smart move? – The less you put down, the higher the mortgage insurance will be. Yep, there is that pesky PMI again, which, for many first-time buyers, pushes their monthly payment to a level they are not comfortable with. Another issue with PMI: if you need to pay PMI, the loan amount you can get will be slightly smaller, to allow for the bigger payment which will determine the house you can afford.
You may also have trouble qualifying for a loan even if you have a high enough credit score because you would not have enough cash reserves after the down payment. If you are using all your savings for the down payment and the lender questions where the funds for your closing costs, taxes and insurance, and any needed repairs are coming from, you could have a problem.
Even when you add the PMI and a higher interest rate, the equation comes out in favor of the lower down payment. With three percent down and making adjustments for rate and PMI, the rate of return on a low-down-payment loan is still be as high as 106 percent – much higher than if you made a large down payment. The less you put down, then the larger your potential return on investment could be.
The case for somewhere in between – Finding that balance between down payment and savings is a challenge for many homebuyers and the sweet spot will be different for everyone depending on their unique circumstances and financial situation. Most financial experts will say that saving and scrounging to get together 20 percent at the risk of depleted savings and zero emergency funds is a shaky strategy.
If putting 20 percent down means that you would use all of your savings, then do not do it! Especially, when you consider all the added costs you may be facing once you buy: yard work, home repairs and maintenance, renovation costs, property taxes, insurance, association fees, etc. It is important to consider all of the costs and not just compare the monthly mortgage payment to your current rent amount or mortgage payment on your old house.
Another thing to consider when evaluating how much you should put down is what would happen if you had an emergency. It is easy to lose sight of real-life issues that can arise when you are so driven to buy a home and focused on saving the money to get there. v