We’re Breaking it Down: When Waiting for 20% Down Is The Wrong Choice

published Nov 16, 2017
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A 20 percent down payment is the gold standard held up by every real estate resource ever. With less than 20 percent down, you’re on the line to pay PMI — private mortgage insurance — a fee that’s tacked on to your mortgage every month for no other reason than to protect the bank (not you) if you ever default on your loan.

PMI goes away eventually (once you have enough equity in your home that you own 20 percent of it — either because your home has increased in value, or you’ve paid your original loan down enough over the years), but most people tell you just to try and avoid it.

Wait until you have 20 percent to put down, they say.

But waiting is not always the best bet. The most straightforward way to explain this is with a hypothetical couple and some hypothetical numbers:

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Let’s imagine Nicole and Jane, a couple living in Atlanta. They’re renters, but have been thinking about and slowly saving for a house for a little while now. They haven’t started any sort of search in earnest — just a few nights in with wine and Zillow — but they’ve managed to sock away $18,000 for their down payment. It’s not a lot in real estate dollars, but they’ve worked hard to save it. The homes in the area they’d like to buy are around $300,000 — so a 20 percent down payment amounts to $60,000. They’ll need $42,000 more.

They’re considering moving to a cheaper apartment in a less desirable neighborhood than they live in now. They could easily cut their $2,000 rent in half and painlessly sock away $1,000 per month — which would mean they’d have their $60,000 down payment in 3.5 years (we’re conveniently ignoring closing costs to make a point here, but here’s what you need to know about that).

Three and a half years. Not too bad. But what Nicole and Jane weren’t anticipating when they made that move to the cheaper apartment to save money was that Atlanta’s housing market wasn’t going to wait for them. If we fast forward to three or four years from now, there’s a real risk that the $300k homes in the neighborhood Nicole and Jane were eyeing have $400k price tags now. Their down payment goal — as lofty as it was for them — isn’t enough to avoid PMI anymore, and even though they’re buying with more money down, their monthly mortgage is higher than if they’d bought the same home three years before.

Buying Now

Cost of Home: $300,000
Down Payment: $18,000
Total Mortgage Loan: $282,000

Mortgage payment: $1,686

$1,306 principal and interest
$179 PMI
$202 taxes and insurance

Buying 3.5 Years Later

Cost of Home: $400,000
Down Payment: $60,000
Total Mortgage Loan: $340,000

Mortgage payment: $1,944

$1,572 principal and interest
$125 PMI
$247 taxes and insurance

*Calculated using an interest rate of 3.75% on a 30-year fixed rate mortgage.

In the meantime, they’ve given $42,000 to a landlord (assuming their $1,000 rent hasn’t increased in 3+ years) that they could have been using to pay off a mortgage debt.

Let me state firmly: I’m not saying buying with less than 20 percent down is always the right thing to do. It’s majorly risky. Wagering on home values increasing is just that — a gamble (just ask anyone who owned a home in 2008). You absolutely need to discuss this with a trusted financial expert.

But there is a small truth hidden in here for aspiring homebuyers: If the market is outpacing your ability to save money, you’ll never have more buying power than you do right now, no matter how much you sock away.