Our clients live exciting lives that we like to live vicariously through. We’ve had quite a few of you start the process of purchasing a home (or second home) this year! Planning around a home purchase is a big part of our service offering for clients. Questions that come to mind are… How much should our down payment be? What’s the advantage of putting 5% down versus 10% down? Does anyone put down 20% anymore? Let’s dive in.
Does anyone put 20% down anymore?
Putting 20% down isn’t dead. However, it’s quite uncommon for first time home buyers. According to the August 2020 Realtors® Confidence Index Survey, 74% of first time non-cash buyers put down less than 20% for a down payment. However, 35% of recent mortgages (this includes first time and experienced home buyers) were made with a down payment of 20% or more. It’s a competitive market, and having that down payment helps. The National Association of REALTORS® reported that with tighter underwriting standards, buyers who pay cash or put down large down payments generally win the bid against those with lower down payments.
Should I save more to get closer to 20% down?
Not necessarily. The median existing-home price for all housing types in August 2020 was $310,600. A 5% versus a 20% down payment is $15,530 and $62,120 respectively. That’s a major difference. Especially for our client demographic who are in their accumulation years, juggling student loan debt, investing, and childcare! Even if you can save $2,000/month for your home purchase, it would take almost 8 months to save for the 5% down payment and 31 months (2.5 years) to save for a 20% down payment.
Lenders know this. In fact, they’ve known about this for a very long time. In the 1980s, interest rates were as high as 20%! Can you even imagine?! The government wanted to stimulate more home ownership in the country since homeowners were deterred from such a high rate. In the 1990s, the government started to reduce mortgage requirements (like a down payment) and encouraged subprime lending. Putting less than 20% down has been available for 30+ years. Without it, the real estate and lending industry would be at a standstill.
How does it affect your cash balance?
Putting down 20% is simply unrealistic for most first time home buyers. However, putting down 10% may be much more manageable. But, should you do it? Let’s break down the numbers. Dan and Natalie are looking to buy a home for $300,000*. They currently have $40,000 set aside in their bank account. They are trying to decide whether they should put 5% down ($15,000) or 10% down ($30,000). What should they do? (details and estimates on this situation are provided below)*
In both scenarios, you may also need to bring some dollars to the table for closing costs. Let’s assume 2% of the purchase price ($6,000) for closing costs. Now their total needed for the home purchase is $21,000 for the 5% down payment or $36,000 for the 10% down payment. This drains their $40,000 bank account to either $19,000 or $4,000 depending which down payment they go with.
How does the down payment affect the PMI and interest paid over time?
PMI stands for Private Mortgage Insurance. This is what we all pay for not putting down 20%. Once our loan-to-value ratio is 80% loan and 20% equity, it falls off. If you put down 5%, you pay $10,450 total in PMI ($118.75/month for 88 months). If you put down 10%, you pay $7,200 total in PMI ($112.50/month for 64 months). So that right there is a ‘savings’ of $3,250.
Your interest savings will be even greater. Over a 30 year term, a $300,000 mortgage generates $175,720 in interest payments when you put 5% down. No one likes that figure. By putting 10% down, that total interest payment over 30 years drops to $166,471. That’s a difference of $9,248. When we add up the PMI and interest savings, that equals $12,498.
Why should you still consider putting 5% down?
$12,500 is a lot of money to be saved! For Dan and Natalie, it sounds like they should just put 10% down! In this example, we would disagree. If Dan and Natalie were looking to put an offer on a home today, we would encourage them to only put 5% down.
Why? Because going into home ownership with $4,000 in the bank is NOT advised. As we mentioned in one of our most popular blogs, A Millennial's Guide to a Recession, having an emergency fund is vital. Especially as a homeowner. If an emergency happens and you are unable to pay rent, you negotiate with your landlord. If you are unable to pay your mortgage, it is now impacting your credit score.
Not only that, but your 2 bedroom, one bath Brooklyn, NY apartment is not going to fully furnish your new home. According to a study from the National Association of Home Builders, in the first year after buying a new home, homeowners fork over an additional $10,601.
My last point to consider is this: if you wait to save so that you can increase your down payment while still maintaining an emergency fund, a $300,000 home may increase in value by the time you are ready to buy. Let’s say it increases by 5% to $315,000. Now that $30,000 down payment is 9.5%. That also means the interest and private mortgage insurance savings is less, too!
The difference between putting down 20% versus 5% is obvious. The amount of interest and private mortgage insurance you save is significant. The difference between a 5% down payment and 10% down payment becomes less significant. Going into home ownership with a solid savings balance is necessary. If putting down less is what allows for that, then we would certainly lean towards putting less down. The monthly mortgage on a 5% down payment is $1,791 while a 10% down payment is $1,717. Another insignificant difference. If you are blessed with a bunch of cash, then go ahead and put down what you think is best (or help us help you decide!). But, if it’s a difference of putting 5% down now, or waiting 2.5 years to put down 10%... I would question that tactic.
Think of buying a home or already started the process? Let us help you evaluate your affordability and the impact it will have on your situation. This article is not meant as a recommendation to your specific situation. Schedule your free consultation with us today to get your tailored advice.
*Assumptions used in Dan and Natalie’s $300,000 home purchase example:
City: Portland, OR, Home Purpose Price: $300,000, Closing Costs = 2%, Property Taxes = 1.07% of purchase price, Home Insurance = $1,500/year, Interest Rate = 3.5%, Private Mortgage Insurance = 0.5% of purchase price.
Disclaimer: This article is for informational purposes only and is not a recommendation of Fyooz Financial Planning, Natalie Slagle CFP®, or Daniel Slagle CFP®. Past performance may not be indicative of future results and may have been impacted by events and economic conditions that will not prevail in the future. Therefore, it should not be assumed that future performance of any specific security, investment product or investment strategy referenced in the Article, either directly or indirectly, will be profitable or equal to the corresponding indicated performance level(s). No portion of the Article shall be construed as a solicitation to buy or sell any specific security or investment product or to engage in any particular investment strategy. Any reference to a market index is included for illustrative purposes only, as it is not possible to directly invest in an index. Indices are unmanaged, hypothetical vehicles that serve as market indicators and do not account for the deduction of management fees or transaction costs generally associated with investable products, which otherwise have the effect of reducing the performance of an actual investment portfolio.