Should a Homebuyer Wait to Save 20% For a Down Payment?
Buying that first home is an exciting and intimidating time. Home ownership can bring a sense of self-worth and accomplishment like few other things can. For most it does represent the largest expenditure they’re likely to take on. Properly estimating a budget is essential to understanding how much home one can afford. This includes all initial fees and expenses.
There is more than one school of thought when it comes to what amount a homebuyer should allocate for a down payment towards a home. For years, the standard amount for a down payment was set at 20 percent. While this is no longer always a requirement, it is still highly recommended by many financial professionals. Is this still the best practice?
Benefits of Saving For a 20% Down Payment
Any time a homeowner puts down any less than 20 percent down, the lender will require private mortgage insurance (PMI), which will cause an increase in extra, non-mortgage housing expenses This decreases how much house a homebuyer can afford.
Since a majority of a mortgage payment goes towards interest in the early stages of a loan, it could take much longer than anticipated to reach 20 percent of the initial loan through monthly payments. Plus, there could be additional steps in eliminating PMI beyond repaying 20 percent, depending on the lender.
If the homeowner has a large cash reserve that will not take too much of a hit, then a large down payment could make sense.
Benefits of Paying Less Than a 20% Down Payment
The simplest argument for disregarding the 20 percent down payment is that it’s no longer required for all loans. All other benefits begin with this fact. Conventional loans and FHA loans now allow minimum down payments of between 3% to 5% of the total loan amount.
The popular trend has now become paying the smallest amount possible for a primary residence. Of course, PMI will be a requirement. However, homeowners who decide to save for that large down payment have been saving with that end in mind. Entire life-savings and emergency funds can be depleted due to a large down payment. This leaves little to no cash in place for any home maintenance or emergencies that come along.
Another benefit to paying the minimum is the idea of lost opportunity cost. In other words, spending such a large sum for a large down payment removes the ability to invest any sum of that money or to enjoy any other potential benefit.
Also, if the market values drop, the borrower who paid the minimum is less at risk than the person who paid a large sum. In the case of a 20 percent down payment, that borrower would assume a bigger loss.
Conversely, a down payment has no bearing on market value. In both scenarios, a home has increased in value, yet the borrower who paid less down will see a bigger return on investment.