We have talked extensively in previous blogs about the myth of 20% down payment. This myth has been perpetuated for decades, and arose out of a time when interest rates and defaults were very high, and getting a mortgage was very tough.
You absolutely DO NOT need to make a 20% down payment in order to purchase a home. There are many programs out there that will allow you to purchase a home with as little as 3% down (FHA) or even 0% (VA), and even some conventional mortgage products will accept a smaller down payment.
So if saving enough for 20% down payment is keeping you from buying a home, then talk to a mortgage lender about your options. You may be closer than you think, as long as you have decent credit and stable income.
Especially in the Northern Virginia area, where home values are so high, coming up with 20% can be particularly challenging. For those of you how CAN do it though, there are some compelling reasons to make a larger down payment.
You Might get a Lower Rate
Lenders like bigger down payments. People who make bigger down payments pose less of a default risk, and they are often willing to reward you with a lower interest rate. A lower interest rate could save you a significant amount of interest in the long run.
You Could Save Money
Making a bigger down payment means that you are financing a smaller amount of principal. The higher the principal, the more interest accumulates. By making a larger payment, you may not only be able to make a smaller monthly mortgage payment, but the total you pay (principal and interest) will be less over time, and your equity will grow faster.
You May Stand Out in a Competitive Market
Northern Virginia is still a pretty competitive market, with more buyers than available homes. When you are in a situation where there are multiple offers, the buyer making the larger down payment may look more viable to a seller. Having a buyer back out because their financing isn’t approved is nerve-wracking for a seller. So, if they have a buyer putting down at least 20%, they may take that offer more seriously than other offers.
You Avoid Private Mortgage Insurance (PMI)
Homeowners derive zero benefit from PMI. It protects the bank, not the homeowner or the property, in the event that the homeowner defaults. So it’s just an added cost on top of your already steep mortgage payments, if you are putting down less than 20%. If you are able to put down 20%, you are seen as less of risk, and PMI may not be required.
As you can see, there are certain advantages of making a 20% down payment, if you are able to do so. But don’t sweat it if you can’t. And even if you CAN make the 20% down payment, you should probably consult a financial advisor before you do. It’s possible, with the continued low interest rates, that you may earn more putting that cash to work in other investments, than paying down your mortgage early or making a large down payment.
If you currently rent, and you are trying to save for a down payment, you also need to look at how much money you will pay for rent over the next couple years. Your rent payment is just building your landlords equity, not yours. If you can get into your own home sooner, and start building your own wealth, by making a smaller payment, it may make sense to do so. If you wait a while to buy a home, there are also opportunity costs – in a few years, homes will be even more expensive. You will pay more for the same size home AND miss the opportunity to start building equity when prices are lower.
There is no cookie cutter answer that is right for everyone. You need to weigh all the factors that are personal to you, which may mean consulting a financial advisor, tax advisor, or mortgage expert. We can put you in touch with great referrals that can help you with these decisions if needed. When it comes to buying or selling your home, we are here to help answer any questions and guide you through a better understanding. Please do not hesitate to contact us at firstname.lastname@example.org or phone us at 202.800.0800.