Down payment. The phrase itself is enough to strike fear in the hearts and minds of many homebuyers. More than that, down payments are often the biggest hurdle that a first-time homebuyer faces.
Down payments are misunderstood. Many homebuyers think a 20 percent down payment is required, but that’s not true — it averages about 10 percent overall, and for first-time homebuyers the average is about six percent. This misconception that a 20 percent down payment is required often adds months, and sometimes even years, to the home-buying process.
If you can buy a home with less than a 20 percent down payment, why aren’t more people doing just that?
Private Mortgage Insurance (PMI) is one possible reason. What’s PMI? Here’s how Freddie Mac explains it:
An insurance policy that protects the lender if you are unable to pay your mortgage. It’s a monthly fee, rolled into your mortgage payment, that is required for all conforming, conventional loans that have down payments less than 20 percent. Once you’ve built equity of 20% in your home, you can cancel your PMI and remove that expense from your mortgage payment.
As the borrower, you pay the monthly premiums for the insurance policy, and the lender is the beneficiary. The monthly cost of your PMI depends on three things:
- the home’s value
- the amount of your down payment
- your credit score
PMI can have a big impact on your monthly mortgage payment. Have a look at this table showing the difference in monthly mortgage payment for a $250,000 home with a three percent down payment with PMI vs. a 20 percent down payment without PMI:
Two things stand out there:
- The monthly cost of a small down payment and PMI is, in this example, $320 more than the larger down payment and no PMI.
- A 20 percent down payment is $50,000!
For many buyers — especially first-timers — $50,000 is a lot of money. Many first-time buyers save for 5-10 years before buying their homes because they think they need to make a 20 percent down payment. To save $50,000 in 10 years, you would need to save about $420 a month. On the other hand, with that same $420 a month in savings, you could afford a 3 percent down payment in less than a year and a half.
So the question then becomes … Is it better to save more money over a long period of time to make a bigger down payment and avoid paying for PMI, or is it better to buy sooner with a smaller down payment and pay for PMI?
An article earlier this year by My Mortgage Insider explains what could happen in the market while you are waiting to save for a higher down payment:
The time it takes to save a (larger) down payment could mean higher home prices and tougher qualifying down the road. For many buyers, it could prove much cheaper and quicker to opt for the 3% down mortgage immediately.
Freddie Mac has this advice on the subject of PMI and when to buy a home:
It’s no doubt an added cost, but it’s enabling you to buy now and begin building equity versus waiting 5 to 10 years to build enough savings for a 20 percent down payment.
Based on results of the most recent Home Price Expectation Survey, a homeowner who purchased a $250,000 home in January would gain $50,000 in equity over the next five years based on home price appreciation alone (shown below).
If you have questions about whether you should buy now or wait until you’ve saved a larger down payment, let’s get together to discuss the current Tri-Cities’ market conditions and help you make the best decision for you and your family.
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