What exactly is the down payment? It’s the amount of money that you, the buyer, kick in out of your own pocket, right at the start, toward the purchase of the house. But exactly how much do you need to put down?
Here’s my feeling about this: always try to put 20 percent down. Period. I’ve been recommending 20 percent forever—since long before the market had its recent huge downward swing. But as so many people fell prey to the idea of putting less than 20 percent down in recent times, we have to talk about this because it’s a big deal and something I feel very strongly about.
Seven Reasons to Put 20 Percent Down
- Improved chance that you will get the mortgage—The first and biggest reason to come up with 20 percent down is that in today’s new market, many banks won’t give you a mortgage unless you come up with at least that much. The loan programs that once existed for 10, 5, and 0 percent down are not just not available.
- Skin in the game—Twenty percent has been the norm forever. It really serves to ensure that the homebuyer has “skin in the game” and is financially viable for the homeownership responsibility.
- Smaller monthly mortgage payment—More money down means you borrow less, which means you will have a smaller mortgage, which means you will have a smaller, more affordable mortgage payment.
- Lower interest rate—The interest charged on a loan with 20 percent down is often lower than the interest on a loan with less money down. Your lower interest rate will save you thousands if not tens of thousands of dollars over the life of the loan.
- No private mortgage insurance (PMI)—Putting 20 percent down allows you to avoid private mortgage insurance. Also called lender’s mortgage insurance, PMI is extra insurance that lenders require from most homebuyers who obtain loans in which the down payment is less than 20 percent of the sales price or appraised value. Many lenders will even add a percentage that is like an insurance policy onto the mortgage interest rate.
- Instant equity building—A significant down payment builds instant equity in your home. A 20 percent down payment immediately puts equity into a property when you purchase it. That down payment safeguards you if the market turns downward temporarily.
- Great saving skills—Saving for a full 20 percent down is a great way to establish practical and healthy saving practices. If you have saved up for 20 percent down, you have probably learned how to manage your money wisely. That skill is going to come in very handy because the money outflow doesn’t stop once the seller hands over the keys to the front door!
Let’s say you have $80,000 saved toward a down payment. You’re wondering, why buy a $400,000 house with 20 percent down when you can buy an $800,000 with 10 percent down? Wow: more house, better neighborhood! Hey, that sounds like a deal. But it’s not.
The entire real estate market and our economy in general were affected by the number of homebuyers who artificially exaggerated their purchasing power with this thinking—buying properties with 15, 10, 5, or even 0 percent down, thinking they were getting more house for their money.
But what really happened was that homebuyers purchased homes that were higher priced and far more expensive than what they could ultimately afford.