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- For many potential buyers, saving a 20% down payment for a mortgage can be a significant barrier to home ownership. Consequently, more people are buying houses with less money.
- A full 20% down payment on the mortgage ensures that you won’t pay for private mortgage insurance and will most likely get the lowest interest rate available.
- Some realtors, however, say the benefits of a smaller down payment outweigh the consequences – it can help homeowners build wealth and equity sooner rather than later.
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Putting 20% down on buying a home is daunting, and rightly so.
For many young Americans struggling with student loan repayments, higher rents and relatively stagnant wages, saving a fifth of a home’s value to get a mortgage just isn’t on the radar.
Prospective buyers find that it can take years to save a full 20% down payment, especially for those who live near a major city, where real estate prices are skyrocketing. According to Zillow, the typical value of a home in Los Angeles is $794,935. You’ll need to save $158,987 to place the 20% down payment.
And for many millennials in particular, that’s just not feasible. A survey of 1,000 Americans considering buying a home in 2020 by the real estate site Clever found that 70% of millennials planned to deposit less than 20%. Twenty-seven percent planned to pay less than 10% on the purchase of their home. Survey data from the National Association of Realtors found that 73% of Americans who bought a home in November put down less than 20%.
These days, the practice of depositing less than 20% to secure a mortgage is becoming more common, and estate agents say it’s a convenient way to get into the market.
Buyers traditionally put 20% less to lower their interest rate and avoid insurance
The 20% figure comes from the minimum payment that most lenders require to avoid paying private mortgage insurance, an additional monthly payment that can cost anywhere from 0.2% to 2% of the principal balance of the loan. Banks charge PMI to borrowers who deposit less than 20% to get some protection if the borrower stops making mortgage payments.
Corn Christian Morrissona Keller Williams real estate agent in South Dakota says that in areas where home values are rising rapidly, paying a small amount of PMI each month can be worth it while your home’s value increases.
“I had a client who bought a house in early 2018 and he didn’t put any money down,” Morrison said, explaining that the client used a state program in South Dakota that allows people to buy a house without making a down payment. . “They had to have a PMI on it, which was costing them an extra $86 a month.”
“At the end of 2019, they went back to the bank to see what the equity stake was right now,” Morrison continued. “And because of the appreciation, their loan-to-value ratio was 76 percent.” Loan-to-value ratios compare the size of your loan to the total value of the home, and generally, loans with loan-to-value ratios below 80% do not require private mortgage insurance.
When the value of a mortgage reaches 78%, private mortgage insurance is automatically cancelled. You can request its cancellation earlier, however, once your loan-to-value ratio reaches 80%.
In this buyer scenario, the market helped the person reach 20% equity in just under two years. In a growing market, Morrison says, the PMI can disappear quite quickly. As the value of the home increases, the loan-to-value ratio decreases, making your loan eligible for PMI removal.
As for interest rates when you deposit less than 20%, they can be slightly higher – Morrison says he generally sees interest rates for customers who make little or no down payment go up by around 0, 25%. However, this percentage may vary by state. It’s also possible to refinance later to get a new interest rate on your mortgage, although you must have an appraisal and pay closing costs to complete the process.
You can buy a home with less than 20% down, and it’s not uncommon
Morrison bought his first home in 2019, aged 24. “I put 5% less on my house, which cost $157,700,” he told Business Insider. His down payment totaled approximately $7,800.
Putting in 5% allowed him to start building equity sooner rather than later. “Where I live in the Black Hills our appreciation is starting to increase,” he said. “We’re starting to ramp up to the point where if you don’t have a down payment, your interest rate may be a quarter of a percent higher, but you’re going to earn so much equity during that time. It’s either wait six months to a year and save some money, or pay a little higher interest and earn a lot of capital.”
In his personal home buying strategy, it worked. “My house was $157,000 and it’s already worth $185,000,” Morrison said.
In Morrison’s business experience, he estimates that 90-95% of his clients have made down payments of less than 20%.
In other parts of the United States, especially in more expensive areas, it is becoming common to make a smaller down payment. “I think 10% is, if not the new normal, it’s acceptable,” said Corrie Watterson, realtor in Seattle. “Even if you’re below that, if you have a conventional loan at 3% off, it probably won’t impact the quality, price or location of the house you can afford. “
Focus on the monthly payment, not the down payment
For those who want to get the lowest interest rate possible and make their offer stand out as much as possible, a 20% down payment is always something to aspire to.
“Everyone likes to drop 20% if they can,” Watterson said. “It helps distinguish their offer from other offers in a multiple offer situation. The smaller the loan, the less uncertainty there is, if you have a financial contingency, that the loan could potentially fail somewhere between the acceptance of the offer and closing.”
But for Watterson, the down payment isn’t the primary consideration when considering buying a home. “The most important thing is to make sure you’re sure you can make your monthly mortgage payment, no matter how much you put aside,” she says.
Note that PMI increases your monthly payments – for someone with a typical good credit score between 720 and 759, ValuePenguin reports that your private mortgage insurance will cost 0.5% to 0.41% of the value of your home each year. But PMI payments don’t last forever. As you accumulate equity, you can stop earning it.
In Watterson’s experience, a lower down payment has become a way for many to get into home ownership and start building equity, despite the higher costs.
“Equity is still the main component of wealth for Americans who aren’t already wealthy,” Watterson said. “As long as you are confident that you can afford that potentially higher monthly payment at 3% down payment, at 10% down payment – versus 20% down payment – I encourage my clients to consider this.”