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Wait to Buy? The 20% Down Payment Myth

April 29, 2022

If you’re looking to buy a home and don’t have the 20% down payment, then this article is for you. A lot of people are under the impression that if they don’t have 20% down, they can’t buy a home. Or some may be worried that with less than 20% down on a first time home buyer loan, they’ll have to pay mortgage insurance every month. The truth is that many lenders offer loans with as little as 3% down. Also, if the market is strong, waiting till you have 20% could cost you more on lost home equity and higher home prices in the future. Managing Broker, Nathan Jennison, walks through a side-by-side comparison of buying now vs waiting until you have 20% saved up.

Transcript

20% Down Payment or Mortgage Insurance

Nathan Jennison: Hi, everyone. I want to talk briefly about a question that we get asked a lot by our customers, especially by our first-time home buyers. And that question really is whether or not they should buy now with a small down payment and get stuck paying the monthly mortgage insurance or whether or not they should hold off, save and then by a few years down the road when they could put 20% down and avoid having to pay mortgage insurance. That is advice that is widely held. And often, given that we hear consistently, and I really want to take a look at it because I’m not sure that it holds up water. So let’s take a look.

Nathan Jennison: So, Wait to Buy? The 20% Down Payment Myth.

Five Year Comparison

Nathan Jennison: My bias is coming through already. So we’re gonna do a five-year comparison. Let’s base this scenario on a few key measurables. All the loans that we’re looking at are conventional loans. We’re going to base that on a credit score of 720, which is a good credit score. Um, this will affect the mortgage insurance.

Nathan Jennison: When we start dropping below 700, we probably want to go with an FHA loan because the mortgage insurance increases quite a bit, but an FHA loan is going to have lower mortgage insurance, but you pay it for the entire lifetime of the loan. The only way that you get out of it is either to sell the property or to refinance into a conventional loan. The purchase price on the home that we’re going to look at is going to be $500,000.

Nathan Jennison: We’re going to keep it relevant with the current Denver market. So this is kind of in the middle right now. And then, we’re also going to use a historical housing appreciation rate of 3.8%. Again, we want to be conservative. This is what Freddie Mac says has been the average appreciation over the last 30 years nationwide.

Scenario: Buy Now with 3% Down Payment

Nathan Jennison: So let’s look at our first scenario, buy now. Now there’s upfront costs that we want to look at breaking this down. There’s a purchase price $500,000. So we’re going to put down a 3% down payment. 3% is the minimum down payment that we can use for a conventional loan. Here, that’s going to be $15,000. Direct loan costs, which is the underwriting fee, title, appraisal, and any costs associated with getting this loan.

Nathan Jennison: We’re going to say $5,000. Again, being conservative. We often come in lower, closer to four, but let’s go with five. Prepaid costs, escrows, and taxes. So again, this is homeowner’s insurance that you pay for an entire year. Any taxes that you got to pay upfront, creating the escrow pool that you need so that your homeowner’s insurance and property taxes get paid out of that on out of your mortgage insurance, out of your mortgage payments.

Nathan Jennison: So that’s going to be $3,700. So the total upfront costs, this is approximated because every house is different, it’s going to be $23,700. Now let’s take a look at the mortgage insurance that everybody’s scared of paying. Again, going with the 720 credit score. So the mortgage insurance with that score is $258 and 33 cents per month.

Nathan Jennison: That’s a lot of Starbucks. The amount spent over one year $3,099.96. And over five years, we’re talking about $15,499.80. That’s a big chunk of change, and it completely makes sense why people want to avoid paying that. So let’s take a look at that home appreciation again, a conservative rate of 3.8% of what that home is valued at the end of five years.

Nathan Jennison: Well, after year one, your $500,000 house is now worth $519,000. Year two, year three, year four. And after holding it for five years, the market value of your home is $602,500. That’s significant. Now, don’t forget that along the way, you were making your payments on time. And part of your payments is paying down principal or basically paying down the loan on your house.

Nathan Jennison: And in this point, you’ve now paid $25,626 of principal that gets added to your equity. So your home equity at the end of five years is $143,125. Congratulations. Let’s look at the scenario of buying five years later; we’re going to say that this buyer saved $20,000 a year, which is difficult to do to put down 20%.

Scenario: Buying 5 Years Later with 20% Down Payment

Nathan Jennison: Again, looking at the upfront costs, the purchase price on a house that was $500,000 five years ago is now 602,500. So that 20% down payment, that’s $120,500.

Nathan Jennison: Your direct loan costs, we’re going to keep them the same and prepaid costs, et cetera. We’re going to keep the same. So the total upfront cost approximated is $129,200. Oh, that mortgage insurance. Yeah, you don’t have to pay it. You have a 20% equity in the property because you just did that with your down payment.

Nathan Jennison: So, mortgage insurance is no longer required. Now, let’s look at your home appreciation over that five years. Uh, well, you don’t get any principle because we didn’t make any payments yet, and you don’t have any appreciation. So your equity position at the end of five years is actually $129,200 because you just bought the property.

Nathan Jennison: Now let’s compare that to the other person who bought it five years ago, $143,125. Ones clearly better than the other, but Hey, we didn’t have to pay that nasty mortgage insurance. Now let’s take a look at something a little closer to home. So the Denver average appreciation rate over the last ten years is 9.31%.

Nathan Jennison: That’s pretty significant. So let’s say you buy a house at $500,000 at the year after year one at 9.31%. That house is now worth 500. I’m sorry. $546,550. Year two, year three, year four. And after holding it five years, that same home is now worth $780,314, assuming the market continues the same way as it has the last ten years.

Home Equity of $320K vs $15K Mortgage Insurance

Nathan Jennison: Principal paid over that five years. Again, don’t forget. $25,626. So the home equity at the end of five years is $320,940. That is significant. This is the reason why we keep telling our customers. It’s far better to buy now and pay the mortgage insurance than to risk being outpaced by a market that continues to grow.

Nathan Jennison: It’s what happens with leveraged money. So that $15,000 might be painful, but it’s far more painful to miss out on this type of equity. Really appreciate you listening. Thank you.

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