January 5th, 2017 5:16 AM by Jackie A. Graves, President
There’s a reason most people don’t purchase a home on a whim. From
appraisals and inspections to closing costs and down payments, the upfront cash
required can take years to save. However, thanks to low-down-payment loans now
on the market, homeowners can have keys in hand to that home for sale in
Charleston, SC, or San Antonio, TX,
with significantly less cash out the door. But is purchasing a house with
little to no money down a good financial move?
If you’re weighing your down payment options before diving into a home purchase,
here are a few things to consider.
What are the types of no- or low-down-payment
There are several no- or low-down-payment loan options available for a wide array of
financial situations. We’ll highlight just a handful.
VA loans: Reserved for active-duty and honorably
discharged service members, reserves, National Guard members with at least six
years of service, and spouses of service members killed in the line of duty, VA loans require 0% down and no private
USDA loans: Also known as the “rural housing loan,” this
0%-down loan is meant to help low- to moderate-income households in eligible
areas that are in need of housing but may be unable to qualify for other loans.
FHA loans: With more lenient approval requirements than
conventional loans, FHA loans also require as little as 3.5% down.
However, mortgage insurance premiums will have to be paid for the life of the
Conventional loans: It’s possible to get a conventional loan with as
little as 3% down, but just as with FHA loans, there’s an additional
requirement of private mortgage insurance (PMI). However, once you reach 20%
equity in the home, this additional cost can be dropped.
What are some of the reasons to put less than
20% down on a home?
You don’t have the cash upfront
Many people struggle to come up with a 20% down payment, but that
doesn’t mean they can’t handle the monthly mortgage costs. For example, you may
have recently paid off your student loans,
leaving you free of debt but also leaving you without enough savings to afford
a lump-sum payment at the beginning of your home-buying journey.
You aren’t planning on staying in the home for
the long run
It’s a gamble to purchase a home you plan to sell within a shorter
time frame (say, three to five years), but if that’s the plan, the cost of a
20% down payment could wash out the savings of a lower monthly payment. Plus,
this practice puts your potential profit from the sale of the home at risk,
since you’ll need time to build equity (and hope real estate prices rise).
You need the liquid funds
you prefer a larger emergency fund, plan to invest liquid assets elsewhere, or
need cash to put toward a home remodel, you may want to protect your liquidity
by minimizing the amount of your down payment. It’s all about your personal
comfort level when it comes to your finances.
What are the upsides to making a smaller down payment?
1. Your money might be more useful elsewhere
There’s a chance the money could offer a bigger savings or return
if used elsewhere. For instance, if you have $20,000 in credit card debt at an
interest rate of 16% and a minimum monthly payment of 2% of the balance, you
would be paying $400 per month (plus interest). Now let’s say you want to buy a
$200,000 house at 3.92%. A down payment of $40,000 would put your mortgage
payment at $756.50 (plus the additional $400+ per month for the credit card).
However, if you cut the down payment in half (to redirect the funds to pay down
the credit card) and increase your home-loan interest rate to 4.02%, your total
monthly mortgage payment would be $861.42. In this case, the greater monthly
savings comes from paying off the card.
2. You can keep your cash liquid
Unless you plan to move out, pulling equity out as cash requires refinancing — a potentially costly endeavor. A
lower down payment can keep more of your cash liquid in case life circumstances
require a cash expenditure in the near future. Without this cushion, you could
potentially put your home (and living situation) in jeopardy.
What are some downsides to a smaller down
1. You may have to pay PMI or mortgage
insurance premiums (MIP)
To mitigate the additional risk of lending to a borrower with a
small down payment, lenders usually require private mortgage insurance for
conventional loans until the homeowner has at least 20% equity in the home. All
FHA loans require homeowners to pay mortgage insurance premiums for the life of
2. You’re likely to have a higher interest
rate and closing costs
The best interest rates don’t automatically go to the borrowers
with the best credit score — the size of the down payment makes a difference as
well. This higher rate translates into higher monthly payments and more money
spent over the life of the loan. In addition, since closing costs are a
percentage of the total loan amount, borrowing more means higher costs.
3. You will have less equity upfront
The less money you put down, the less equity you will have once
the home officially becomes yours. This could mean you can’t take advantage of
home equity loans or lines of credit if your home needs repairs for which you
can’t afford to pay cash. It could also increase your chances of being
underwater in your home (owing more than what the home is worth) should the
So, what’s the bottom line?
Conventional wisdom might say 20% is always the way to go, but
more options and different financial circumstances put this to the test. Make
sure to fully explore the loan options available to you before deciding on the
down payment amount that suits you and your situation best.
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