5% vs. 20% Down Payment

I recently got asked by a couple friends who were starting to save to buy their first home together: “Tyler, Should we save until we have 5% or hunker down and save until we have the full 20% down payment, which is better?” 

My advice in almost every case, as it was in this case, was to start looking for a home as soon as the 5% is saved. The sooner you can get into the Real Estate market and start having the natural growth of the market working for you the better. I like to think of an owned home as a bank account. If I put a $25,000 down payment down on a house, have I lost that down payment? No. It’s still there and I can get it back when I sell! Additionally, every mortgage payment I make I’m adding a little bit to that amount as well, slowly building up that bank account of equity. The cherry on top comes when the market naturally increases in value, known as appreciation. 

All these factors support my belief it is almost always better to buy sooner than later and if that means putting 5% down, then so be it. 

“But Tyler, what about the extra Mortgage insurance fees? On a 500k purchase they’re almost 19k, pretty much double my down payment. “

Let’s explain this Insurance. Anyone putting below 20% down payment on a home will be required by the lenders to be an insured mortgage. Meaning if you default and the house becomes worthless the insurance companies will still pay the lenders back. This is also why Lenders will offer BETTER interest rates on insured mortgages. There’s virtually no risk for them. But there is an initial cost to this which gets added to the mortgage.

For example, the buyer purchases a 500k and puts a 5% down payment of 25k. The total amount of mortgage required would be the remainder of 475k plus the insurance cost of 19k. So the total mortgage amount would be 494k. 

This is the main reason buyers would rather wait for the full 20%. It may seem like you’re losing money to the insurance company, but in the long run you will make more money.

We’re going to take a look at two scenarios. It will be assumed that each Buyer has the financial capabilities of saving $25,000 per year. Buyer 1 made the choice to buy year 1 using 5% down while buyer 2 waited till year 4 and a down payment of 20%. 

5% vs 20% Downpayment Over 4-Year Period

As you can see. Due to mortgage pay down, and appreciation the Buyer who bought sooner with 5% down came out with an additional $130k at the end of 4 years. Additionally if we think about what types of house could be afforded in each scenario, Buyer 1 definitely bought a nicer home. 

A couple things to consider. The Insured mortgage definitely gives you higher mortgage payments per month if the home value remains the same. This is where working with a mortgage broker will help. Start with a mortgage payment you’re comfortable and you can work backwards from there. 

As always, I’m happy to answer any additional questions. Or if you want to be put in touch with a broker let me know. I work with some of the best!