If you’ve talked to anyone about your plans to buy a home, than you’ve probably been told that you need to save up for a 20-percent down payment. That’s a scary thought considering the median home price in Orange County, California is well over $800K. Yikes!
But thankfully, you you have options when it comes to the size of your down payment. While a large down payment may offer more favorable terms, you can actually buy a house with a much smaller down payment.
Not only do you have the option of making a small down payment, but it can actually be a savvy financial move in some situations. Even if you have the money for a large down payment available, paying as little as 3, or even 1 percent may be more in line with your goals.
The Down Side of Paying Less
The downsides of a small down payment are pretty well known. You’ll have to pay Private Mortgage Insurance for years, and the smaller your down payment is, the larger your insurance premium will be. You will also likely pay a higher interest rate than if you make a smaller down payment, BUT this is not always the case.
Sometimes, you actually get better pricing on the rate by making a small down payment. This is because the bank bank’s risk is actually being reduced by the mortgage insurance that you have to buy.
The Upside of a Small Down Payment
The national average for home appreciation is about five percent. The appreciation is independent from your home payment, so whether you put down 20 percent or three percent, the increase in equity is the same.
This is pretty interesting if you are looking at your home as an investment. If you consider the down payment to be the investment amount, than the actual rate of return you are getting is better with a small down payment because the amount of equity appreciation is the same.
However, your monthly payments and interest costs will increase, so it’s not exactly a slam dunk.
So Which Option is Better?
It all depends on your goals. Are you buying a home to eventually pay off and keep forever, or is this a stepping stone for you? Would you rather have cash in the bank, or a lower monthly mortgage payment. In Orange County, California home prices are high and a 20% down payment can easily exceed $150,000. For some people, that’s a lot of money to lock up in a relatively illiquid asset.
There are pros and cons to both large and small down payments. For a more in depth look, check out these 2 articles…