If you’re going to be buying a home any time soon, you’re going to need to start thinking about your downpayment. Typically expressed as a percentage of the sales price, the downpayment is often one of the more difficult obstacles for people to overcome on their way to home ownership. You’ll need to budget your money and save up enough to make your downpayment, but how much will you need? You’ve probably heard the rule – you’ll need to save for a 20% downpayment before you buy a home. The logic behind saving 20% is solid, as it shows that you have the financial discipline and stability to save for a long term goal and it can also help you get favorable interest rates from your lender. Additionally, the bigger your downpayment, the less you need to borrow, so the less you’ll pay in interest in the long run.
But there can actually be financial benefits to putting down a smaller downpayment — as low as three percent – rather than parting with so much cash up front, even if you have the money available.
The Downside of a Small Downpayment
The downsides of a smaller downpayment are pretty well known. You’ll have to pay private mortgage insurance (often referred to as just PMI) for years, and the lower your downpayment, the more you’ll pay. You’ll also be offered a lesser loan amount than borrowers who have a 20% downpayment, which will put some higher priced homes out of reach for you when searching.
THe Upside of a Small Downpayment
The national average for home appreciation is about five percent. The appreciation is independent from your home payment, so whether you put down 20% or three percent, the increase in equity is going to be the same. If you’re looking at your home as an investment, putting down a smaller amount can lead to a higher return on investment, while also leaving more of your savings free for home repairs, upgrades, or other investment opportunities.
The Happy Medium
Of course, your home payment options aren’t binary. Most borrowers can find some common ground between the security of a traditional 20% and an investment focused, small downpayment. It’s always a good idea to talk with your Realtor and your lender to discuss the potential paths for you and to see what strategy works best for you and your personal needs.
image courtesy of AleXander Agopian