Which Payment Strategy is Right for You?

You’ve most likely heard the rule: Save for a 20% down payment 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. It also helps you get favorable rates from lenders

But there can actually be financial benefits to putting down a small down payment—as low as three percent—rather than parting with so much cash up front, even if you have the money available.

THE DOWNSIDE

The downsides of a small down payment are pretty well known. You’ll have to pay Private Mortgage Insurance (PMI) for years, and the lower your down payment, the more you’ll pay. You’ll also be offered a lesser loan amount than borrowers who have a 20% down payment, which will eliminate some homes from your search.

If you are doing a conventional loan, the PMI will drop off once you have 20% ownership in the home. If you are using a government backed loan such as FHA, the PMI will remain for the life of the loan, therefore the only way to eliminate it is to refinance.

THE UPSIDE

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 3% percent, the increase in equity is 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 down payment. It all depends on your goals for the home. If you need cash to do a remodel or upgrades than it makes sense to save your cash and finance more of your home. On the contrary, if the home is move in ready and you have the cash to lower your monthly mortgage payment, then why not? It’s a personal decision based on your current situation. The plus side is, gone are the days of strict 20% down payments. Buyers now have more options when purchasing a home.