We hear this from homebuyers a lot: “Wait, I don’t have to put 20% down?” Nope! You don’t have to. In fact, you can put as little as 5% down and there are legitimate reasons why it’s actually a good idea. Depending on what you choose, 20% or less, there are pros and cons. Let’s take a look.
Why Put 20% Down?
First, why is 20% the standard? Because banks and lenders prefer it. If you put 20% down on a home, in their “eyes” you are seen as less “risky.” To them contributing a big chunk of cash up front means you’re more likely to make your monthly payments down the line.
Putting 20% down up-front, means that you’ll get:
- Better interest rates
- Lower monthly payments
- No private mortgage insurance (PMI) – more on this below
- More equity
- Lower closing costs
It makes sense – you pay more up-front, you’ll pay less as you go along. But scraping together 20% down is hard and for some people, nearly impossible. And for those who can make it happen, they may not want to put all of their eggs – in this case, cash – in one basket.
Why Put Less than 20% Down?
- Leverage: This is the best reason against putting 20% down. Leverage is an investment strategy – it’s using borrowed money (your home loan in this case) to finance an asset (your new house). When you only put 5% down on a home, the bank gives you a loan for the other 95%, and you get the financial upside on all 100% of that home value’s growth. For example: you buy a $500K home, and put $25K down (5%) and the bank loans you $475K. Over 5 years, let’s say your home appreciates by 10%, that’s $50K. You get that 10% appreciation to keep – all $50K of it. You effectively made $50K on a $25K investment. That’s the power of leverage.
- Cash: Keep your cash available for your rainy day fund, home repairs, retirement, investment, savings, and closing costs. You don’t need to drain your savings to own a home.
- Timing: You may get into the home market sooner, before you get priced out of certain neighborhoods. Here in Seattle, neighborhoods like Beacon Hill and Columbia City are up-and-coming. It’s only a matter of time before those neighborhoods become unaffordable for most buyers.
The big con to putting less than 20% down:
- Private mortgage insurance (PMI)- because the bank views lower down payments as higher risk, they add this to your mortgage payment each month.
It’s a personal choice
Ultimately, it’s up to you how much you want to put down, there’s no “right answer.” It’ll come down to your homeownership and financial goals.
So think about the following:
- Do you view your cash as invested in or tied-up in your home?
- Will you feel strapped each month or will you have cash leftover after you buy?
- Do you think your home will be a good investment, depending on when and where you buy?
- What’s your timeline for buying?
- Will you be able to buy in your neighborhood or will you get priced out by the time you’re ready?
Depending how you answer each, you may get a better sense of your down payment target, and you can end the age-old down payment debate, well, at least for yourself, and that’s who matters.
If you feel like there’s a gap between how much you want to put down and how much you have in savings, Loftium can help!
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