What’s a Realistic Down Payment on a New House?

mortgage down payment

With interest rates rising, many prospective first time homeowners are curious whether or not they should purchase a home now (while interest rates are still low), or if they should wait until they can save up a larger down payment.

In this post mortgage crisis era, there are still many different types of mortgages that don’t require a 20% down payment (FHA and VA loans being among the most popular).  So, does it make sense to put down less than 20% on a new home?

A user on Reddit’s personal finance boards recently posted this comment.

We have 6k in savings and plan on trying to buy a house next fall with an FHA loan. The savings goal is 20k. I know the gold standard is 20% down, but we are looking to start a family soon and don’t foresee saving for a few years. We also don’t want to get screwed on interest rates as they rebound. So it will most likely be 3.5% down. Our house price ranges would probably be around 225-250k.

While it’s understandable that the person is concerned about rising interest rates, it’s never a good idea to let fear drive your personal finance decisions.  Here’s a few reasons why it’s not a good idea to put less than 20% on a new home.

Private Mortgage Insurance:  One of the biggest reasons why it’s not recommended to pay less than a 20% down payment on a new house is that you’ll be required to pay private mortgage insurance or PMI.  On a $250,000 mortgage, your average monthly PMI premiums will be around $150-170 until your mortgage balance is less than 80% of your home’s value.  In fact, interest rates would need to rise over 1 percentage point to achieve an equivalent monthly mortgage payment with PMI.

No Equity in Your Home:  Another disadvantage of paying less than 20% down on a new home is that you’ll have virtually no equity in the home.  In the example above, the individual is looking at putting down 3.5% on an FHA loan (a very expensive type of loan to begin with).  If something where to happen (job relocation, medical emergency, etc.) they would effectively be “upside down” in their home.  Even if they could sell their home for what they paid for it, they wouldn’t receive enough money to pay closing costs and brokerage fees.

Home Values May Decline:  Another consequence of rising interest rates is the possibility that home prices taper off or decline given that people will qualify for smaller mortgages than they would have with lower interest rates.  This is another reason why you should never let fear dictate your personal finance decisions; the market has a way of equalizing itself out.

Cash Flow:  If you pay less than a 20% down payment on a new home, you’re also jeopardizing your ability to rent the home out in the event you can’t sell it and/or need to down size.  Your monthly mortgage payments will likely be much higher than what an equivalent monthly rental would cost meaning you’d have to supplement any renter that rented out the property.

There’s a reason why 20% is the “gold standard” when it comes to down payments on new homes; anything less than that and you’re setting yourself with too much risk.  If it takes you longer than 2-3 years to save up a 20% down payment for your ideal home, you’re most likely looking at homes that are too expensive.

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