Real Estate Down Payment: Gone in 60 Seconds?

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So, a few weeks back I wrote a post “How Far Down Can My Savings Go For a Down Payment” discussing just how much first-time home buyers need to have in the bank for a down payment. And I received a few great comments. One in particular asked, “What happened to 15 – 20% equity…?”

This got me thinking. With FHA loans allowing just 3.5% down payments on home purchases, is this too low? As we save money for a down payment on our first home should we but aiming to contribute more to our down payment — possibly to the tune of 20% down?

Sidebar: A buddy of ours was over at our apartment and we were discussing home purchases. When he bought his home 3 years ago, he put 30K down. Now… based on the new value of their home, if they wanted to sell they’d be upside-down. That 30K is virtually gone.

So, here’s my question. With more of the country’s work force falling out at rapid rates and seemingly slamming housing values further into the ground, is it still wise to put the largest down payment possible into your home? Could it be a better financial decision to put 3.5% down, and put the remaining amount in a safe interest-bearing account — even a CD — until you sell the home? Or, if the home needs repairs, since HELOCs are no longer available is it best to just preserve your money in a low interest-earning savings account so that you can guarantee you have something to draw from. 

The Drawbacks

I suppose PMI would factor into the decision. PMI could be higher with a lower down payment. As where a 20% down payment would eliminate PMI payments completely.

And your interest rate could factor into your down payment decision. Some lenders charge higher interest rates for larger loan amounts. But, here’s another challenge: Could it be more beneficial to purchase points upfront to buy down your rate rather than contribute a heavier down payment? Particularly when that down payment could dissipate pretty quickly.

Another thought: Okay, so what if your home value does decline beyond your 3.5% down payment and you need to sell. You’re upside-down, but now, at an even greater level than you would’ve been had you contributed a higher down payment. With a greater down payment, you would’ve at least broken even. I hear you. But let’s assume you put an additional 6.5% into a CD (or something similar) and you earned a decent amount of interest on it during the time you’ve lived in your house. You still have the money to bring to the table at closing to break even, but now you have more of it thanks to the interest you’ve earned. Was it worth it?

Right now the number of potential home loan clients turned away for a failed-value appraisal is enough to make me at least raise the question.

Frankly, I don’t have the answers. Interest rates, home values and monthly mortgage payments are based on a myriad of factors that could vary the true answer on a case by case basis.

That said, if you’re a first-time home buyer… or even if you’ve sold you’re home and you’re moving on to a new one, my goal here is to at least suggest you do the math based on your situation. Weigh your options: Higher loan amount with lump sum amount preserved in a safe, FDIC backed interest-bearing account, OR lower loan amount with higher down payment poured directly into the house.

Is the interest rate and monthly PMI payment enough to outweigh the security of knowing exactly where your money is? Knowing exactly how much you have? Or is it still better to invest more in your home?

I’m interested to know what you think. If you find yourself doing the math, please share your comments and results!

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  1. Wouldn’t you also have to consider how long you intend to hold onto the property? If it’s a primary residence that you intend to hold for a while, it seems to me that your risk of being upside down at the time you decide to sell is a lot lower — so it might be a better decision to make a bigger downpayment and take a lower interest rate. The savings over many years on interest would presumably be substantial. (In fact, it would be worthwhile to determine how much you’d save both due to the lower rate and lower principal — might be as much or more than you’d lose by being upside down by a modest percentage.)

    The other thing is, if you have lower payments, you seem a bit more able to make the payments during a lengthy unemployment, should you be unlucky job-wise down the road.

  2. Interesting question. I think your overall point about “doing the math” is really the right one … because if you paid higher points for a lower mortgage, would you also have to pay PMI (presuming the downpayment is low)? But I do think you want to factor in how long you plan to stay, because it does impact the risk of value loss. And of course one of the things we’ve all learned recently is the desirability of an affordable payment — i.e., comfortably affordable, not the max you can afford!

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