The Benefits of a Smaller Down Payment

According to the National Association of REALTORS® (NAR), the biggest misconceptions regarding the home buying process are related to the down payment. It’s not uncommon for hopeful buyers to hold off on their homeownership dreams as they save for the targeted 10 or 20 percent down. But, in its June 2019 REALTORS® Confidence Index Survey, NAR reported that 60 percent of homebuyers actually financed a home using a 6 percent — or less — down payment.

While there are definitely benefits of having a heftier down payment, you may be surprised to find there are also some advantages to putting down less.

Getting into a home sooner
Saving 20 percent for a home purchase can take many years, so it’s no surprise that one of the biggest benefits to buying a home with a small down payment is that it allows more buyers to enter the housing market sooner.

Looking at the length of time it takes to save for a down payment, Veritas Urbis Economics put together some approximations based on a middle-class salary and the purchase of a median-priced home (around $252,000). The study found that, assuming you’re putting away at least 10 percent of your income, it could take the better part of a decade to save $50,500 for a 20 percent down payment. However, after just 18 months, a buyer could save $8,250, enough for the minimum 3.5 percent down on.

In addition to a Federal Housing Administration (FHA) loan, there are other government-backed mortgage programs that require little-to-no money down, like those offered by the United States Department of Agriculture and the Department of Veterans Affairs. There are also several conventional mortgage programs that accept as little as 3 percent down, and some lenders may offer products with an even lower down payment for qualified buyers.

Allow for emergency savings
Even if you have a significant amount of money saved, it can be scary to part with all of it. Small-down-payment mortgage programs give buyers the ability to have money left after closing, and Denya Macaluso, assistant vice president with Michigan State University Federal Credit Union, says having that extra cushion is critical to successful homeownership.

“Annual home maintenance and repairs can range anywhere from $1,000 to $10,000,” she said. “These costs are not usually a focus for buyers when purchasing a home, but they are really important to keep in mind. For instance, if your air conditioner suddenly stops working, it could cost around $4,000 to replace. Many homeowners would have difficulty covering this additional cost without having to borrow the funds.”

In addition to maintenance and repairs, it’s also important to consider unexpected life events that can negatively impact finances. What if you lose your job? What if there is a medical emergency? Would you have enough money to handle the hurdles that come up while still making your monthly mortgage payments? To help lessen the burden, homeowners should have a reserve of cash that’s large enough to cover at least 3-6 months’ worth of living expenses.

Free up money for improvements
Did you take on a bit of a fixer upper? Does your home need some small cosmetic improvements? Will you need new furniture or some first-time homeowner must-haves like a lawnmower or snow blower? Hanging on to extra cash can help cover the costs of necessary purchases and improvements.

“If buyers drain their savings for the down payment, it would take them longer to complete any updates, and they may need to eventually take out a home improvement loan or home equity loan in order to complete the work,” said Macaluso.

Consider the drawbacks
Of course there are benefits of “going big.” A higher down payment means a smaller monthly payment, and you may also be able to qualify for a lower interest rate, which will save you money over the life of the loan. When you put down at least 20 percent on a home, you also skip the need for private mortgage insurance (PMI), which typically costs about 0.5 to 1 percent of your loan balance per year, but could be a bit higher or lower depending on each borrower’s financial situation.

But, while there are advantages of a larger down payment, Macaluso does not like to say there are “negatives” of putting down less.

“Low down payment mortgage programs and PMI companies have made homeownership possible for millions of Americans,” she said. “The decision of how much to put down really depends on an individual’s financial situation, future goals, and comfort level.”

For more information, consider setting up a consultation with a local, professional lender. A list of area experts can be found by visiting the Greater Lansing Association of REALTORS® website at www.lansing-realestate.com.