If you’re buying a home, you probably can’t afford to purchase it outright. Rather, like most people, you’ll put some money down on that property, and you’ll get a mortgage to cover the rest. The question is: What should your down payment be?
Should you make a 20% down payment?
Many financial experts will tell you that to buy a home, you’ll need to come up with a 20% down payment. And that’s not bad advice. But it’s also not a must.
First of all, you can purchase a home for as little as 3.5% down with an FHA loan, if you qualify for one. Even if you get a conventional loan, you can get still away with not putting down 20%. However, if you make a down payment that’s lower than that, you risk getting stuck with private mortgage insurance, or PMI.
PMI is typically paid as a premium that’s tacked onto your existing mortgage costs. Its purpose is to protect your mortgage lender in the event you’re unable to keep up with your mortgage payments. And it can be costly, easily totaling 1% of your loan amount. On a $400,000 mortgage, you’re potentially looking at $4,000 a year in PMI costs, which is why it’s often a good idea to come up with that 20% down payment at the time of your closing.
Another benefit of putting down 20% of your home’s purchase price? You’ll build equity sooner. Equity is the percentage of your home you own outright, and the more you have, the better, since you can borrow against that equity when you need money.
That said, if you can’t swing a 20% down payment, but have enough income to afford your mortgage payments plus PMI, you may be just fine putting down less. You might live in a housing market where prices are inflated. Or, you may be embarking on a new, lucrative career, like medicine or law, but don’t have much money for a down payment because you’ve spent the past few years in school. As long as you can swing PMI on top of your mortgage (plus the general cost of maintaining a home), there’s nothing wrong with going that route and owning sooner rather than later.
The same holds true if you’re looking to invest in real estate. You may not have enough money to put 20% down on an investment property, but if you can afford the monthly payments associated with owning it, there’s no reason not to move forward. Besides, if that property does well and you’re able to generate a substantial amount of rental income, you can use that money to cover your higher mortgage costs, or pay into your mortgage so that eventually you’re able to cancel your PMI.