5 Reasons to Scrimp for a Down Payment

Posted on February 13 By MLP Blog

Of the million or so hurdles you can encounter between you and your first home, the down-payment hurdle can sometimes loom the largest.

Lenders can make it easy to buy a house without the traditional 20% payment, but that doesn't mean doing so is always to the advantage of the new homebuyer. As you've doubtless been reading lately, lenders such as New Century and Accredited Home Lenders (Nasdaq: LEND) helped lots of buyers get into a home, but now many of them are facing default and potential foreclosure.

So let's look at five reasons why it's better for your pocketbook if you scrimp and save and delay your home shopping until you can make that traditional down payment.

  1. When you approach a lender with a 20% down payment in hand, you can typically negotiate better loan terms. You'll often get a wider choice of loan options, and you'll be in a better position to optimize your loan rates, terms, and other features. The bottom line — you'll save money.
  2. Without a 20% down payment, you could be asked to pay private mortgage insurance, since the lenders' number-crunchers have determined that people buying a home without the traditional down payment tend to be more likely to default. Unlike your mortgage payments, the PMI money goes straight to your lender with little advantage to you. It does not reduce your loan interest or principal, and it's not tax-deductible.
  3. Some lenders let homebuyers avoid paying PMI by taking out a second mortgage loan, often called a "piggyback." In most cases, you'll have one loan for 80% of the home's cost and a second covering as much as the remaining 20%. You get tax advantages that you wouldn't realize with private mortgage insurance — specifically, a deduction for your mortgage interest — but that second loan typically comes at a steeper interest rate than the first.
  4. Without a sizable down payment, you'll have very little to no equity in your home for a long time. For some buyers, home equity can provide much-needed peace of mind that they'll have a source of cash in an emergency.
  5. Without any equity, you might also end up in a truly unfortunate position if home prices drop in your neighborhood. In that situation, you could owe more on your mortgage than your home is worth. That may not be a problem if you're planning to sit tight for a long time, but if you're suddenly forced to move, you'll have to come up with the difference. You could feel a serious squeeze on your finances as a result.

Maybe now you're convinced that saving up that 20% first is a good idea, but in some regions of the country, average home prices are high enough to make putting away 20% very difficult. In that case, shift to Plan B — save as much as you can, even if you don't think you can reach the 20% goal. By having at least some money to put down, you'll be able to drop your PMI policy sooner, since you're required to pay for that insurance only until you have 20% equity in the house. And if you have a second "piggyback" loan instead of PMI, you'll minimize the amount of money you have to borrow at higher interest rates. Your diligent savings habits might even make it possible for you to accelerate your payments and knock out that second loan pretty quickly. You'll also move into your house with a little bit of equity, and maybe a little more peace of mind.

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