Updated: Nov 15
Hindsight is 20/20, right? And in hindsight, maybe I should have saved 20% when I bought my first house. But my opinion has always been there is there is no one perfect way to engage in real estate.
Yet there are things I wish I would have known when I invested in real estate without a 20% down payment in the bank. This includes understanding the extra costs involved, how to reduce them, strategies to simplify the process, and alternative options.
Everything is cheaper
Sure, the actual cost of the down payment is higher by saving up the full 20% to spend as down payment. The benefit is that all of those dollars go directly to your equity. Plus, the more money you put down the smaller lots of other costs will be on closing day...and over the life of the loan!
Equity: eq·ui·ty: /ˈekwədē/
Equity in real estate is the difference between the fair market value of the property and the amount of money you owe on the mortgage. Your equity can increase by paying down the principal or the value of your home rising.
IE: Putting $20k down on a $100k home means that on closing day you have $20k of equity going towards your net worth. Every month you pay your mortgage, all things being equal, the contribution going towards your principal positively and directly impacts your equity. In general the more equity you have the higher return on your investment.
Pay Less Interest over time: The more you put down the less interest paid over the life of the loan. So in our 100k example, putting 20% down means you will only pay interest on 80k. But if you put 10% down, you will owe interest on 90K.
The WORKAROUND: Most mortgages allow you to pre-pay principal without penalty. So even if you don't have the full 20% today, you can plan to pre-pay principal to save future interest.
Pay Smaller Closing Costs: Lots of the additional fees paid on closing day are based off the amount of the loan. So the more you are borrowing, the higher costs will be on closing day.
The WORKAROUND: Before you whip out your checkbook to cover these costs, review with your lender and negotiate. Discuss with your lender what fees, they are willing to cover or waive.
One Less Bill
If you put down less than 20% of the purchase price, most lenders will require you purchase Private Mortgage Insurance (PMI) costing between 0.5. to 1.0%. This equates to up to $1k/ year for every $100k of loan dollars. That is $1k a year you would not need to pay if you put the full 20% down.
Avoid PMI altogether by taking out a separate loan to cover the cost of the difference between your down payment and 20% of the sale price. While this adds a level of complication to your home buying process and means you will technically have TWO mortgage payments (even if your lender rolls them up together), it will save you from paying the PMI bill.
Down the road, when your home increases in value, you can eliminate your PMI by refinancing. This is dependent on your home value growing enough that you owe less than 80% of its current value regardless of how much you borrowed or put down. So if you only put 10% down and your home value has risen 15%, you now owe less than 80% of the house value; the tipping point for PMI requirements.
Be the Most Popular Buyer
Sellers will see the finances behind each buyers offer: This includes how much you are putting down, how much you are borrowing, etc... All things being equal, besides the purchase price, sellers will consider your financing resumé when deciding between multiple offers. How do you look 'on paper'? Don't dismiss that the seller could choose the buyer who is bringing the most cash to the table. Some sellers may even accept a lower bid, if the buyer has stronger finances.