Before making a 20 percent mortgage down payment, read this
What is a down payment?
A down payment is the amount of cash you put toward the purchase of a home.
It may be expressed as a percentage. For instance, it usually takes a 20 percent down payment to buy a home without private mortgage insurance. It may also be expressed as a dollar amount. As in, you have $15,000 available for a down payment.
How much should you put down on a house?
So, the question most home buyers face right away is, “Should I make a large down payment?”
Each buyer should come to his or her own conclusion. But it’s becoming more popular not to make a large down payment, for several reasons.
Why do mortgage lenders (sometimes) require down payments?
Down payments are all about lowering risk for the mortgage lender. Statistically, the more the homebuyer invests upfront in the property, the less likely he or she is to default on the loan.
For this reason, lenders often offer lower mortgage rates to buyers with higher down payments. However, the lenders’ assumption is flawed.
The USDA loan is the best-kept secret in the mortgage market. It requires zero down, plus credit guidelines are loose. Eligibility is location-based. Many rural and suburban neighborhoods across the U.S. are USDA-eligible. This loan is perfectly suited for first-time and repeat buyers, and you don’t have to have a high income to qualify.Check your USDA eligibility now
VA home loan
The VA home loan is available to home buyers with eligible military experience -- as little as 90 days of service in some cases. This mortgage option has no down payment requirement. Plus, no mortgage insurance is required, potentially saving buyers hundreds per month.Check your VA loan eligibility status now
This loan allows entire households to contribute to the mortgage payment. The primary buyer can use income from non-borrowing household members to qualify. Income from roommates, boarders, and mother-in-law units is allowed. This loan requires a small 3% down payment, all of which can come from a gift from a family member or other eligible source.Get preapproved via the HomeReady™ loan
The Conventional 97 gets its name from its small 3% down payment requirement. This program is best for home buyers who would otherwise qualify for a standard conventional loan, but don’t want to make a large down payment. Fannie Mae and Freddie Mac sponsor the program, which makes it widely available nationwide.Get a Conventional 97 loan approval here
The FHA mortgage is the go-to program for more than 20% of home buyers. It requires a small down payment and is well-suited for borrowers with imperfect credit histories or lower income. This is a government-sponsored program designed to get more people into their own homes. Therefore, guidelines are flexible, and buyers often qualify when they thought they could never own a home.Check your FHA eligibility here
Standard conventional loans come with a 5% down feature that not a lot of buyers know about. Many assume loans sponsored by Fannie Mae and Freddie Mac come with a 20% down requirement, but that’s not the case. Ask your lender about the 5% program, and enjoy the benefits of a conventional loan without the steep down payment requirement.Check your Conventional 95 eligibility now
An 80-10-10 loan, otherwise known as a “piggyback” loan, is a mortgage option in which a home buyer receives a first and second mortgage simultaneously: one for 80% of the purchase price, and one for 10%. One loan “piggybacks” on top of the other. No mortgage insurance is required because the lender considers the 10% second mortgage part of the buyer’s down payment..Check your 80-10-10 rates now
You can put just 10% down on a conventional loan, despite the popular belief that these loans require 20%. This option requires private mortgage insurance (PMI), which is typically very affordable. In many cases, opting for PMI is a better strategy than trying to come up with 20% down.Check your conventional loan rates now
Conventional loans come with very low rates, plus no mortgage insurance is required when you put 20% down. Conventional loans are sponsored by Fannie Mae and Freddie Mac and available at your local lender. Conventional loans remain the mortgage of choice for buyers with good credit and a healthy down payment. A conventional 20% down loan can also be used to buy a second home or investment property.Get Pre-Approved For Your Conventional Loan
Multi-unit & investment properties
You can buy a duplex, triplex, or four-plex by making a down payment of 25% or more. Purchasing a multi-unit home is a great way to get started as a landlord, whether you plan to live in one of the units or rent out the entire building. Homes with up to four units are eligible for conventional lending.Get Pre-Approved For An Investment Property Now
Exceptions that (don’t) prove the rule
VA loans, for instance, require zero down, yet have one of the lowest default rates of any loan type.
In addition, the lower default rates among those who can meet higher down payment requirements may have little to do with the “skin in the game” argument.
Homebuyers who can make a massive upfront investment tend to be more financially stable and established in their careers.
High down payment requirements may have nothing to do with the fact that they did not default.
So, while you might hear that it’s more “conservative” to make a large down payment, it’s only partly true: it’s more conservative for the lending institution.
A large down payment is actually riskier for the home buyer.
Should you make a larger down payment?
How much should you put down on a house? As much as possible?
There’s nothing wrong with that, as long as you’re not also carrying high-interest debt. You might be better off zeroing those balances first. You also don’t want to sacrifice retirement funds or your emergency account.
Those who pay more upfront, without depleting all their assets, probably should. It saves on mortgage insurance, for one thing.
A large down payment helps you afford more house with the same payment. In the example below, the buyer wants to spend no more than $1,000 a month for principal, interest, and mortgage insurance (when required).
Here’s how much house this homebuyer can purchase at a 4 percent mortgage rate. The home price varies with the amount the buyer puts down.
|Percent down||Dollar amount||Principal & interest/MI combo||Home price|
Even though a large down payment can help you afford more, by no means should home buyers use their last dollar to stretch their down payment level. It’s not conservative at all, for the following three reasons.
3 good reasons for putting less money down on a home
Just because you can put more money down on your home purchase doesn’t mean you should.
1. You can’t get your down payment back (easily)
The whole point of a down payment is to tie up money in the house.
With that money unreachable, lenders say, the homeowner will continue to make their payments.
That’s not necessarily a bad thing. The money is “sitting there” for when you sell the house someday.
However, a financial event can leave you wishing you had access to the money without selling. Say you lose a job for three months. An extra $20,000 would be a nice safety cushion.
And, if you lose your source of income, you can’t take home equity out via a cash-out refinance or home equity line of credit (HELOC). Lenders won’t approve a new loan to someone between jobs.
In short, the more you need to get at the money, the less access you have to it.
2. You’re at risk when home value drops
A down payment protects the bank, not the home buyer.
Home values are tied to the U.S. economy. Most of the time, the economy is making incremental gains, and home prices rise.
But sometimes, the economy falters. This usually happens after extended periods of too-hot growth. That happened in the late 2000s.
In this situation, consider two home buyers:
- Buyer A: Puts 20 percent down on a $300,000 home
- Buyer B: Uses FHA to put 3.5 percent down on a $300,000 home
Buyer A, thinking he is being “conservative” puts $60,000 down on a home. Buyer B puts down just $10,500.
If home values fall 20 percent neither Buyer A nor Buyer B have any equity in their homes. However, Buyer A lost a much bigger amount.
Plus, Buyer B carries less risk of being foreclosed on if she can no longer make her payments. This is because banks know they will take a bigger loss repossessing a home with a larger outstanding loan balance.
So, really, which home buyer is more conservative? The one who puts the least amount down.Verify your eligibility for a low down payment loan (May 20th, 2018)
3. A down payment will lower your rate of return
Even if you’re a conservative investor, if you want to maximize your return on investment, you’ll monitor your down payment size.
Consider a home which appreciates at the national average of near 5 percent.
Today, your home is worth $400,000. In a year, it’s worth $420,000. Your down payment size has no bearing on the rate your home appreciates. In this example, your home is worth $20,000 more.
That down payment affected your rate of return.
- With 20 percent down on the home — $80,000 –your rate of return is 25 percent
- With 3 percent down on the home — $12,000 — your rate of return is 167 percent!
Don’t forget mortgage insurance…
However, we must also consider the higher mortgage rate, plus mandatory private mortgage insurance which accompanies a conventional 97 percent loan. Low down payment loans can cost more each month.
Assuming a 175 basis point (1.75 percent) bump from rate and PMI combined, then, and ignoring the homeowner’s tax-deductibility, we find that a low down payment homeowner pays an extra $6,780 per year.
Even though it doesn’t matter
With three percent down, and making adjustment for rate and PMI, the rate of return on a low-down-payment loan is still 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.
Use a HELOC to increase liquidity
If you’ve already made a large down payment, you can still decrease your risk with a home equity line of credit.
Do it while the economy is doing well, lenders are offering HELOCs, and you have a job. If any of these factors evaporate, access to your home’s equity is extremely limited.
You can open a zero-balance line of credit. You pay nothing in interest until the moment you draw funds from it. It’s just like a credit card (with much lower rates of interest).
For instance, you open a HELOC with a $100,000 limit. You draw nothing. In an emergency, you draw $5,000 per month or as needed, until you’re back on your feet.
It’s a convenient, low-cost way of turning your home’s equity into potential cash.
And if your home value drops or you lose your job, you can still take cash out. The terms of the HELOC don’t change based on home value or employment status.
A zero-balance HELOC is probably the easiest way to build a financial cushion quickly if you’ve tapped most of your liquid assets to make a large down payment.
What is my eligibility for a low down payment home loan?
When you’re planning for a down payment, there are additional considerations beyond “how much can I afford to put down”. Consider your down payment in the context of your tolerance for investment risk, as well.
Get today’s live mortgage rates now. Your social security number is not required to get started, and all quotes come with access to your live mortgage credit scores.Verify your eligibility for a low down payment loan (May 20th, 2018)
The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.