At some point, you’ve probably heard that you need to save 20 percent for a down payment on a house. The reality? You can purchase a home with a lower down payment. And in some instances, doing so may even be a financially savvy move.
Somehow the 20 percent rule emerged as a gold standard in real estate, but its origins are murky, as Marketplace, a podcast focused on the economy, points out. The down payment rule is traced all the way back to the Great Depression, and is no longer a requirement for home buyers.
In fact, the average down payment for first-time homebuyers is 5 percent, according to the latest snapshot of real estate trends from the National Association of REALTORS®. The association points out that the ongoing climb of home prices is pulling down the typical down payments for first-time buyers. Meanwhile, those same high home values are giving sellers the ability to use cash to make bigger down payments on their new homes—but they’re still only putting down 14 percent on average. Altogether, the median down payment for homebuyers was 10 percent, according to the The 2017 NAR Profile of Home Buyers and Sellers.
Suffice it to say 20 percent down is not just outdated, but it’s also not a reality for every homebuyer.
Here are a few reasons why you might want to put less than 20 percent down:
If you’re renting while you save, you’re not building equity
One of the reasons people aim for a 20 percent down payment is to avoid paying private mortgage insurance, AKA PMI. Most lenders require the insurance policy if you put less than 20 percent down. Typically, PMI will cost between 0.3 percent and 1.2 percent of the loan on an annual basis.
But, if you’re sacking away money in savings, waiting to reach that 20 percent mark, you could be missing out on the financial perks of home ownership, even when you factor in the costs of PMI. The money you’re paying in rent is going to your landlord, rather than building equity on a fast-appreciating home of your own.
Also, some cities are experiencing record-low rental vacancies, which is driving rent costs up and leading to steep, year-to-year rent increases. As an example, rent in the Denver-metro area rose nearly 47 percent between 2010 and 2017. With rent increasing at such a fast pace, it can hamper your home savings goals.
You don’t want to miss your window to buy
If you’re waiting until you hit a 20 percent savings target, you could be missing out on the prime time to buy. As Eave’s COO Saro explained earlier this month in our Mortgage Rate Report Roundup, now is a great time to buy, especially if you’re in the market for a luxury home. That’s because interest rates are projected to rise, and those looking buy would be smart to take advantage of the lower rates while they can. But it gets better: the luxury home market is a buyer’s market right now, according to the Institute for Luxury Home Marketing’s latest report. Meanwhile, it’s a seller’s market for starter homes, which can also play in your favor if you’re planning to upgrade. So you could potentially save thousands by upgrading soon.
However, it’s important to understand that the smaller your down payment, the higher mortgage rate you’ll pay. So a smaller down payment may not always make financial sense in the long run. It’s always best to spend time comparing the potential benefits and drawbacks of buying sooner while rates are lower versus waiting until you have a larger down payment. Buying a home is a huge decision, and not one to be taken lightly! Always speak to a trusted financial adviser before jumping into anything.
You may have better cash flow
Even if you do have 20 percent to put down after selling a starter home or hitting a savings goal, it might make sense to keep some of that money in a high-interest savings account or have it available for renovations that you want to make. Having a cash cushion can be a great benefit after moving and paying closing costs. Also, if an unforeseen financial emergency occurs, having liquid assets can be helpful.
The takeaway here? You shouldn’t let the myth of 20 percent hold you back from purchasing a home.
At Eave, we believe finances are not one-size-fits-all, and lending shouldn’t be either. If you are currently thinking of buying a home, our licensed mortgage experts can help you decide what size down payment makes the most sense for you. Visit our website to speak with one of our loan officers today.