We’ve all heard the rule of thumb: Save for a 20% down payment before you buy a home. The logic behind saving 20% makes sense, as it shows that you have the financial discipline and stability to save for a long-term goal. It can also help you get favorable rates from lenders. However, there can actually be financial benefits to putting down a smaller down payment—as low as 3% —rather than parting with so much cash up front, even if you have the money available.
It’s important to understand the downsides of a small down payment. You’ll have to pay Private Mortgage Insurance for years, and the lower your down payment, the more you’ll pay. You may also be offered a lesser loan amount than borrowers who have a 20% down payment, which will put some homes out of your reach. Finally, your down payment has a significant impact on the total cost of your home. For instance, your interest rate on the home is calculated, in large part, based on the amount of your down payment. The larger your down payment on a house, the lower your interest rate will be, and the less you’ll wind up paying for your home over time.
National home prices increased 4.4% year over year in January 2019 and are forecast to increase 4.6% from January 2019 to January 2020, according to the latest CoreLogic Home Price Index (HPI®) Report. The appreciation is independent of your down payment, so whether you put down 20% or 3%, 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.
Some Middle Ground
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. Ultimately, the size of your down payment on a house depends upon multiple variables, including your personal financial situation, your age, your marital status, your income, your credit health and how much you’ve been able to save for a home purchase. Your trusted real estate professional can provide some answers as you explore your financing options.