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Why should I put down 20% when I can put down 5% and save more per month? When my wife and I had our real estate business, this was a question my wife and I heard a lot while discussing how our clients were saving for a down payment. Our reply typically was, “Why should you pay PMI, or Private Mortgage Insurance?
OK, time for a quick teaching lesson. When you go to buy a house, the banks determined that a safe buyer is a person saving for a down payment that is 20% of the home’s value. Therefore, if you put down less than 20%, you will be charged a monthly fee often referred to as PMI.
Be aware that this insurance isn’t for you. Rather, it is for the bank. They are insuring themselves against the possibility that you will default on the payments and the bank will be required to seize the house.
If that doesn’t put things into perspective for you, let’s do a quick history lesson now and talk about the housing crisis.
The 2009 housing crisis.
As you will recall, the housing market came to a screeching halt because people bought more house than they could afford.
What happened again? Well, they used the easy lending requirements at the time to qualify for more money. They put down less, bought nice furniture, and took lavish vacations. Then, they lost their job or had a few rough months — and boom — they couldn’t make the mortgage payments anymore and the bank took the house.
For many people out there, they didn’t even know they couldn’t afford the house. The reason for this was twofold. One, monthly payments started off so low due to adjustable rate mortgages (or ARMs) and balloon payments.
Secondly, since homes were incredibly easy to buy, people never thought about what they would do in year 5 when they could no longer afford the payment and couldn’t sell their home that was now underwater.
Does that ring a bell? If so, great. If not, please read your (not so distant) history. It’s so important that you don’t repeat mistakes you made and learn from the mistakes of others. Learn from things like our failure with buying too much house. That’s a cautionary tale if there ever was one!
How this affects your saving for a down payment on your current home purchase.
OK, so I’ve gone on and on about this, what is the point? The point is you will want to avoid purchasing a home where the monthly payment is too expensive for you. Don’t buy a house simply because people tell you to.
More importantly, you need to be prepared. And I can’t stress this enough. Not everybody should buy a house.
There, I said it. You can bash me all you want, but it’s the truth.
I know there are deals out there and ways to entice people to buy. There are low income based programs, military programs, and even adjustable rates that make things more affordable in the beginning. There is a lot of that out there. Sure, lots of it is well intentioned.
However, step back for a second and consider why banks required 20% down of the home value for the longest time. Are they just greedy bastards? Well, the short answer is no.
Further, requiring 20% down for the home you’re about to buy protects you just as much as it protects the bank.
How so? Well, there are four areas I see where the 20% down rule favors the buyer. We will cover these more below, but I’ll share them with you now first. 20% down:
- Helps you avoid PMI, which would increase your monthly payment,
- Establishes a great deal of equity in your home right away,
- Sets you up to pay your house off early, thus saving you thousands in interest payments, and
- Means you are truly invested in this home and be the catalyst to help you be a better money manager (if you’re intelligent enough to realize it).
You can avoid private mortgage insurance (PMI) if you’re saving for a down payment that is 20% of the home value.
Do you like paying more for something than you have to? Probably not. I know I hate it.
Not everybody has to pay PMI. Don’t be the one that does. Don’t be the person that “insures” the bank. They have enough money.
Rather, do the hard and long work of saving for a down payment that is a full 20% of the purchase price of your next home. That might mean getting less home than you planned and/or waiting longer than you planned.
Don’t be discouraged by this. Embrace the concept of delayed gratification. It is OK (and the world will not end) if you don’t have something you want right this second.
Do yourself, your family, your wallet, and your psyche a favor. Do it right. You will thank yourself later (and be sleeping each night like a baby).
Establish home equity right away.
Putting 20% down on your home essentially means you have instant equity. You “own” 20% of your home. So, if you paid $200,000 for your house, you have equity of $40,000.
Granted, $40,000 is a lot to come up with. I get that. Then, maybe you go for a $100,000 or $150,000 house. Or just bite the bullet and save up.
It all comes down to priorities and taking responsibility. Will it be a vacation, a car, or saving up for your home?
Set yourself up to pay off your home.
Now, that you own 20%, why not go for the extra 80%? Get a plan together to pay off your home early.
How much of your take home pay do you need to put aside? Think it’s not doable? Think again.
It all comes down to planning and it all starts with that 20% down payment. Set yourself up to own your home free and clear.
Then, dream of possibilities that will come your way once your living situation is completely paid for! Now, that is financial health. That is financial power.
You have more financial knowledge after it’s over.
Take the time to learn about the home buying process. Have your real estate agent and mortgage lender educate you. Ask many questions. This is not a time to be passive and let others make the hard decisions for you.
Furthermore, this is your purchase. You are the one signing on the dotted line. You are the one who will make the monthly payments — and the one responsible for all the repairs. It all comes down to you.
So, take all advice (no matter the source) with a grain of salt. Be polite and listen to everyone. Don’t act like you know everything because you don’t. But, question everything and everyone with boldness. This is not a time to be timid, but a time to learn all you can.
Doing this will help you not only in your home buying purchase process, but in all other financial decisions as well. You will be confident in your ability and comfortable asking questions. That is worth it’s weight in gold. Only a fool thinks he or she knows everything.
Conclusion: To be financially healthy, you need to be financially prepared.
If you are thinking of buying a house, you should make sure that you are prepared financially. Nobody wants to wake up in the middle of the night with sleep terrors worrying that they can’t afford the roof over their heads.
Part of being financially prepared is saving for a down payment that is 20% of the home’s value, money for closing costs and an emergency fund. Failure to do so puts yourself and your family in jeopardy. There is no house in the world that is worth losing sleep over.
Are buying a home or do you own a home? Are you saving for a down payment? Did you put 20% down? If not, do you regret it or are you content with your monthly mortgage payment? Please share your thoughts below. Thanks!