If you missed the previous article, you can find it here.
An Uncommon Problem
In the majority of cases, first time homebuyers struggle to make the minimum. In January 2006, USA Today reported that 43% of first time buyers put no money down. In some cases, these people secured financing through non-traditional loans like interest-only loans or flat minimum payment loans as well as ARMs, 100% mortgages, and graduated payment mortgages. We now know where this trend led in late 2007, but the return to more stringent downpayment requirements hasn’t helped new homebuyers at all.
The PMI Pitfall
Putting something down on your home is very important, no matter what terms your lender offers. First, if you put less than 20% down, you will require private mortgage insurance (PMI). This is required by banks to make certain that they are not left empty-handed should you default on your mortgage. PMI can add hundreds of dollars to your yearly payments.
Homeowners with PMI need to watch their house’s value very carefully and, when the house appreciates enough and the mortgage is paid down to where the balance owing is less than 80% of the house's value, have the property appraised and the PMI removed. If you put nothing down, you may end up paying thousands of dollars in insurance fees before you can get the PMI off and focus on just paying the mortgage.
Size of Downpayment
Now, if you can put down 20% or more, what should you do? Let's assume that you have 30% to put down. If you were to put down 20% and invest the other 10%, you would need to find an investment that returned more than the interest you pay on your loan – although the interest is still tax deductible, you would probably be better served by putting more down as your investment would necessarily be higher risk and most likely taxed.
If you put down more instead of investing it, you would lessen the monthly payments. This has two advantages. First, assuming your house appreciates over time, you own more of that appreciation by owning more of the house outright. It is possible to argue that a larger downpayment is either a low-risk investment or, at the very least, a convenient way to protect some of your money from inflation.
Second, you pay more out of your savings now in order to free up more monthly income for investing – albeit in smaller amounts. In the opposite situation, you have more money to invest in a lump sum and then little or nothing in the following years. In most cases, putting a lump sum in the market outperforms investing in small, regular intervals, but you have the extra burden of loan interest offsetting a large chunk of your potential gains.
The Need for a Downpayment
In the current mortgage market, you are going to need a downpayment. Speaking from a purely financial context, that downpayment should be as big as you can reasonably make while keeping your other obligations. That said, if you are going to put down a large downpayment and then decorate your new house using credit cards, the argument is reversed – a large, low-interest mortgage is better than high-interest credit card debt. This concludes the purely financial side of buying a home, the side you have to consider before you ever pick up a paper and skim the real estate section. The next few articles will look at the evaluation process of both neighborhoods and properties in .
