Did you know that you don’t have to put 20% down on a home to get financing? Today many programs allow down payments as low as 3% and there are even programs that don’t require a down payment at all.
While this sounds ideal, it may not be the best for everyone. Keep reading to learn the pros and cons of making a small down payment on a home.
The Benefits of a Small Down Payment
First, we’ll start with the benefits of a small down payment.
- You’ll have money in reserves. It’s always a good idea to have money in an emergency fund when you own a home. What if something breaks as soon as you move in or you realize that you need to buy a specific appliance? If you don’t have the funds, it can put you in a dire financial situation right away. Instead, you can have the money sitting in your savings account for that rainy day.
- Makes it easier to buy a home – If you can find a loan program, such as the FHA or even a conventional loan that requires a low down payment, you may be able to buy a home sooner than you thought. If you are forced to wait until you have a 20% down payment, on the other hand, it can take longer.
- You increase your rate of return – When you put less down on the home, but your home appreciates, you are able to earn a higher rate of return. The more money you put into the home, the less you make in equity; you are just making back what you put into the home.
The Downsides of a Small Down Payment
Of course, there are downsides to a small down payment.
- You’ll have little equity – If you ever want to access the home’s equity to make improvements to the home or even pay for another large expense, you won’t’ have any for quite a while. Gaining equity in the home with a small down payment can take many years.
- You’ll pay mortgage insurance – Whether you opt for a conventional loan or a government-backed loan, you will pay mortgage insurance on the loan. If you take an FHA or USDA loan, you will pay mortgage insurance for the life of the loan. Conventional loans only require it until you owe less than 80% of the home’s value.
- You’ll pay a higher interest rate and have a higher payment – The less money you put down on a home upfront, the more your payment will cost you. Lenders typically charge higher interest rates because of the higher risk of default. Your payment will then be higher but even with the same interest rate, your payment will be higher because of the higher amount of your principal balance.
- It’s tougher to win the bid on the home – If you are trying to buy a home in a competitive market, sellers may favor the buyers that put more money down on the home. A higher down payment often means an easier time getting financing, which is what the seller wants as they don’t want to lose the offer that they accept.
It’s a Personal Decision
Each situation is different when it comes to making a down payment. Sometimes a large down payment is good, especially if you will stay in the home for the long-term and you have reserves set aside on top of the down payment. If you aren’t sure about your longevity in the home or you worry about your financing future, though, making the smaller down payment may be the better option.
You have to weight the pros and cons of each side. It helps if you talk to a few lenders and even your tax advisor to see which option will suit you the most in the long run. It’s not an easy decision to make and it’s not a decision you should rush into. Instead, take your time and decide which option is right for you.