5 Reasons You May not Want to Put 20 Percent Down on a Mortgage
You've probably heard it's preferable to put 20 percent down on a mortgage, but doing so is a huge financial commitment. The main argument to making such a large down payment is that you won't have to pay for private mortgage insurance. In many cases, however, you're better off paying for MI in order to save money elsewhere.
Think of it this way: If you wanted to put down 20 percent on a $400,000 home, you would have to save $80,000. That's a lot of money, especially when you factor in other expenses you have to pay immediately, such as home inspection, closing, and moving costs. In addition, some of that $80,000 could be reserved for other costs, whether for the immediate future or later down the line.
Let's say you want to buy a $200,000 home and you have to save $40,000 for the down payment. Assuming you're putting $600 per month into a savings account that has a 0.29 percent annual interest rate, it will take more than four years until you're ready to buy the house.
A lot can happen in four years, so there's no guarantee you'll be able to put $600 away every month without any problems. Unforeseen medical costs could arise, or issues with your car may result in your need to purchase a new one. In addition, depending on market conditions, it's possible the property you want to purchase will appreciate to the point where the asking price increases, requiring you to save for a larger down payment.
Paying rent in addition to saving for a home could put you in a tight spot when unexpected expenses come up. While Money contributor Cameron Huddleston recommends getting a roommate, or picking up a second job to keep up with your saving regimen, circumstances may not permit you to take advantage of these tactics.
For example, if your career already demands 50 hours a week, but you have small children at home, committing an additional 15 or 20 hours to a second position may not be realistic or worth the additional stress.
Waiting may cost you
According to Bankrate, the average interest rate for a 30-year fixed mortgage stood at 3.27 percent in August 2016—a historic low. Interest rates are starting to climb up—they hovered around 3.64 percent in September, so you don't want to let low rates pass you by.
Consider this: If you want to buy a $312,500 home, you'll pay $1,090 per month at a 3.27 percent interest rate per Bankrate's calculations. However, Bankrate's online mortgage calculator shows that your payment will cost an additional $270 per month if rates rise to 5.12 percent. It's not definite that interest rates will rise to this level, but it's a possibility.
Add value to your home
You may want to use some of your savings to make home improvements to increase your new property's value and equity. Assuming you're purchasing a $200,000 home, there's a lot of work you can do with $40,000 versus putting all that money into a down payment and not being able to afford to do the work in the near future.
For example, Remodeling Magazine's "2016 Cost vs. Value Report" noted that a grand entrance project, which costs $7,971 on average, will recoup 69.9 percent of the cost when you sell your home. Assuming you've saved up $30,000, you still have enough money to make minor renovations.
A 911 fund
Reserving cash for unforeseen emergencies is a smart decision. Trapping much of your savings in a down payment will make it difficult for you to access funds when you need them. Experts typically recommend you save up enough money to cover three months of living expenses to cover a job loss or illness.
Exactly how much money that turns out to be depends on your situation. Money Under 30 noted that ensuring financial security in the event you lose your job—to name one emergency—involves deducing how difficult it would be for you to replace your income.
So before you make the assumption that putting 20 percent down on a home purchase is a must, be sure to weigh the opportunities and potential cost savings that mortgage insurance affords.
Learn more about not putting 20% down.