Should you wait until you can afford to make a 20% downpayment?
2 August 2006Moneycentral asks this question. 20 percent down payments are often out of reach for new home buyers, especially in more expensive markets where that can be $50,000 or so - or more.
So why not jump in with 5 percent, or even less, when lenders seem perfectly happy to offer you loans without the full down payment? Well, they’re happy for a reason:
Lenders are making it a lot easier to buy a house without the traditional 20% down payment, but you’re going to pay a lot for that option. If you borrow more than 80% of the home’s value, you’ll usually have to pay private mortgage insurance, which protects the lender if you default on your loan. That tends to cost 0.5% to 1% of the loan value, up to $3,500 per year on a $350,000 home, or $5,000 on a $500,000 home. It’s money that doesn’t go toward your principal or interest and isn’t tax-deductible.
Their money is going to be safe either way - and you’re paying for that safety.
But I don’t agree with the idea that it’s always bad to buy the house with a smaller downpayment. The article is right that there are several downsides to doing it, but it completely ignores the upsides, namely that:
1) Your house will be appreciating as you own it. Over time, real estate has always gone up. If you own, even if you have no equity, you get the benefit of any increases in the property value.
2) That appreciation might bring you over the 20% equity threshold. You can always refinance for relatively low costs - and if the house increases in value to the point where you own 20% of the equity, you can refinance and get rid of that mortgage insurance payment. Your new loan will have a “down payment” of over 20 percent in existing equity. It doesn’t matter whether you paid for the equity or not - it’s still yours.
3) This is a comparative decision - you’re asking whether it’s better to buy with a smaller down payment now or keep renting. This is the biggest miss of the article - it completely ignores the fact that you’re making a choice. And renting a house can be a horrible one, even compared to owning with a low down payment. Generally, a good rule of thumb is that you should always buy if you plan to live somewhere more than two years. That’s about the time it takes for you to have made a profit after loan closing costs, even assuming no increase in value of the home. This is a good rule because renting has its own downsides - you can deduct interest payments, but not rent. That’s a big one on its own, especially if you pay a lot in taxes each year - it can be more than enough to outweigh the mortgage insurance costs. You also get any gains in property value. There are some upsides to renting - less hassle, no upkeep costs - but on the whole, the 2-year rule is still a good one, even with a low downpayment.
Discuss this on the Free the Drones Forums here.
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