With so many loan options out there, it’s easy for a first time buyer to be overwhelmed. Traditionally, the often-repeated phrase is to save 20% before buying your first home. But with loans such as the FHA loan offering as low as 3.5% down, is 20% still necessary? Even conventional loans like the 30-year fixed only ask for a minimum of 5%. So what’s the benefit of saving the entire 20%?
Saving for a Down Payment – the Benefits of 20% Down
Putting down a hefty 20% on your home will save you from private mortgage insurance (PMI), which is a relatively large savings. If you’re getting an FHA loan, you won’t have PMI. Instead the mortgage insurance premium (MIP) is built into the monthly payments, as well as an upfront one-time MIP payment during closing. The monthly MIP goes away after 5 years and the loan-to-value of your mortgage reaches 78% of the initial sales price or the appraised price of your home (see Bankrate’s explanation).
If you have 20% saved already and you need a 30-year loan, you should look into conventional loans because 30-year fixed FHA loans still require MIP. On the other hand, if you only need a 15-year loan, 15-year FHA loans do not require MIP with 20% down.
Should You Save a 20% Down Payment?
I didn’t. With all these financial benefits to having that 20% down, you might ask why not? The truth is, there’s a cost to waiting. I bought my house about 2 months ago, and I rushed. By waiting, I would’ve gotten a much higher mortgage rate (I believe), and I could have missed the first time home buyer tax credit. Missing the credit alone would’ve cost me $8,000, not to mention the higher interest rate.
For me to save the 20%, I would’ve needed at least 5 years. And in that time, I would have been throwing money away on rent rather than building equity. While this varies by your income and spending habits, it was difficult for me to save a ton of money, and pay rent and all the existing bills at the same time. So, I went for it. I bought a home that was worth $120,000 just 3 years ago for $68,000.
Using the tax credit, we got all new appliances and remodeled the kitchen with new cabinets and granite countertops. So what about the MIP I’m paying? Well, I admit wholeheartedly that not having that would save quite a bit of money. But I calculated my opportunity cost, and in the end it made more sense for me to act now.
Buying a Home in a Buyer’s Market
While the 20% rule is still a great way to plan for buying a home, it’s also important to consider the market you’re in. To miss a buyer’s market such as now, so that you’ll have the full amount during a seller’s market may cost you more in the long run. Of couse every situation is different, so be sure to figure out the costs specific to your needs. For me, the tax credit combined with low property values and low mortgage rates all made now the best time to buy a home in my situation.
If you need help deciding how much money you need for a down payment, be sure to check out our down payment calculator.