A down payment is an important component for most people buying a home. You’ve most likely heard "the rule": Have at least a 20 percent down payment saved before you buy a home. The logic behind saving 20 percent 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. This is in addition to obviously lowering the amount financed against the home, which in effect creates some measure of equity.
There can, however, actually be financial benefits in a smaller down payment—as low as three percent—rather than parting with so much cash up front, even if you have the money available. Let's look at the "downsides" and the "upsides" of a smaller down payment.
The downsides of a small down payment are fairly well known and definitive: You’ll have to pay Private Mortgage Insurance 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 percent or larger down payment, which may eliminate some homes from your search.
The national average for home appreciation is about five percent. The appreciation is independent from your home payment, so whether you put down 20 percent 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 so exclusive, or set in stone at one end of the spectrum or the other. Most borrowers can find some common ground between the security of a traditional 20 percent and an investment-focused, smaller down payment. Your trusted real estate professional can help you contemplate a variety of considerations as you explore your financing options.
Please let us know if we can answer your down payment questions (or any other real estate questions) as you consider purchasing a home—it would be our pleasure!
Authors: Janet & Lance Hooks, Associate Brokers - Greater Denver, Colorado.