As of this year, 67.9% of Americans own a home. Will you soon become one of the many homeowners in the U.S.? Nothing defines the American dream more than being a homeowner. You have a space to call your own and to raise your family. But one of the unpopular aspects of homeownership is the mortgage. In order to not get stuck with hefty monthly mortgage payments, new homeowners have always been told to put down 20% of the home’s worth. But is this really a good idea? Here’s why the typical down payment on a house isn’t always the best option.
Why Not Pay the Typical Down Payment on a House?
A 20% down payment makes sense, right? You’ll have lower monthly payments and will pay little interest. However, paying the quintessential 20% also poses many risks. Here are the disadvantages of a large down payment.
You’ll Have a Hard Time Getting Your Money Back
If you want to buy a home in Portland, be prepared to spend at least $345,500. 20% of that is $69,100. That’s a lot of money that you can put toward retirement or another venture. Unfortunately, there’s a slim chance you’ll get that money back if you need it.
When you make a down payment, that money gets converted into home equity. In short, home equity is what your home is worth versus what you owe to the bank. It’s known as an “illiquid asset,” which means it can’t be readily spent or even accessed.
Does that mean you lose that $69,100? No — but getting it back isn’t easy. You either get your money back when you sell your home or go through home loan refinancing. Both of those options aren’t easy and cost money.
Let’s say you bought a home at $345,500 and paid the minimum down payment, which is about $12,000. You still have over $50,000 to use toward retirement, put in a savings account, or even grow it with interest. If that money is considered to be a liquid asset, meaning you can access and spend it, you can use that $50,000+ if a catastrophe or emergency occurs.
Lowers Your Rate of Return
When putting a down payment on a house, you may think the larger down payment will save you money. But if your home appreciates, your rate of return will be less when it comes time to sell your home.
Does that mean you’re losing money? No. Low down payments do increase your mortgage payments and interest. Other factors, such as insurance, also play a role in home costs.
Just understand that if you think you may sell your home in the next few years, don’t feel bad about putting down a lower down payment.
What If Your Home Values Drops?
If you put down a 20% down payment and your home value sinks, you may be in trouble. Let’s refer to the point about the difficulty getting that down payment back.
If you can’t sell your home and you can’t get a loan on your equity, you just lost a lot of money. Unfortunately, defaulting on your mortgage becomes even more prevalent.
Why do home values decrease? If the economy is doing well, home value increases. If the economy is bad, the home value decreases. And when the economy is bad — even if you price your home well — there’s little guarantee that anyone will want to buy a home when the economy is bad.
When a Bigger Down Payment Makes Sense
The 20% down payment has its risks. Does that mean you should avoid it at all costs? There are times when a 20% down payment makes sense.
First, if you’re looking for affordable monthly payments, put down 20% (or close to that). The more your down payment is, the less you pay in monthly payments plus interest. In addition, putting down the full 20% results in avoiding mortgage insurance.
What Is a Good Down Payment on a House?
Here’s the million-dollar question — if 20% is a risky down payment, what’s the ideal figure? Most homeowners put down between 6% – 12%. However, there is no right answer. The ideal down payment depends on your situation.
Let’s say you have a lot of money saved up in the bank and have a good retirement plan. As long as your income is consistent, feel free to put down a larger down payment.
However, if you have little money saved up, opt for the smallest down payment — even if you make a lot of money. Even though you’ll have to pay mortgage insurance, you can keep more cash in your pocket to save or use toward retirement.
This also depends on the home you’re buying. If you want to buy a home immediately, don’t feel discouraged to opt for a lower down payment. You don’t have to take time to save up money and you can build up home equity fast.
However, if you want to avoid high-interest rates and mortgage insurance, take all of the time in the world to save for a bigger down payment.
What’s the Minimum Amount You Can Put Towards a Down Payment?
As stated previously, the recommended down payment on a house is between 6% – 12% of the home’s value. Does that mean this is the lowest? It depends on your mortgage.
A conventional loan is the most popular type of mortgage. Down payments start at 3% – 5%. If you choose an FHA loan, you can put down 3.5% of the home’s cost. Some loans, such as VA and USDA loans, even let you put 0% down!
Should You Make the Typical Down Payment on a House? It Depends
If you’re buying a home, you’re probably wondering if you really need to make the typical down payment on a house. It depends on your financial situation as well as the home you’re buying. While putting the full 20% down will save you money on interest and avoids mortgage insurance, a bigger down payment comes with plenty of risks.
More importantly, you should choose the best mortgage for you. But not everyone may know their options. Don’t worry, we can help.
If you want to buy a house in Portland, contact us for a 30-minute meeting.