Should you buy a home with 3% down or wait until you've saved 20%?
One of the most common things I hear from buyers is:
“I think I should wait until I have 20% to put down.”
There are certainly advantages to a 20% down payment. Your loan amount is smaller, your monthly payment is lower, and you can generally avoid private mortgage insurance, or PMI.
But there is another side of the equation that buyers sometimes overlook:
What is the cost of waiting?
Consider this simple example.
Buy Today
Suppose Buyer 1 finds a single-family home today for $800,000. (We know average is higher but bear with me).
The buyer has excellent credit, sufficient income and qualifies for conventional financing with just 3% down.
That means:
Purchase price: $800,000
3% down payment: $24,000
Loan amount: approximately $776,000
Illustrative interest rate: 6.875%
Principal and interest: approximately $5,098/month
Estimated PMI (Purchase Mortgage Insurance): approximately $300/month
The payment is higher because the buyer is financing more of the purchase price and paying PMI.
So the buyer thinks:
“Why don't I just rent for another year, save more money and come back with 20% down?”
Sounds reasonable.
But let's see what could happen.
Wait One Year
Assume the buyer continues renting for $2,750 per month.
Over the next 12 months, that's:
$33,000 in rent.
Now let's assume the $800,000 home appreciates by a relatively modest 5% during that year. ( The average over the past 60 years has been higher.)
The house that cost $800,000 now costs:
$840,000.
To put 20% down, our buyer now needs:
$168,000.
Yes, the new mortgage is smaller, and there is no PMI.
Assuming an interest rate of 6.625%, and assuming the general rate environment hasn't changed, principal and interest would be approximately $4,303 per month.
That's clearly a better monthly payment, or is it?
What happened during the year Buyer 1 waited to buy?
Buyer 2, Who Purchased, Was Building Equity
Buyer 2 who bought for $800,000 benefited from the home's appreciation.
At 5%, that represents approximately:
$40,000 in appreciation.
Buyer 2 also paid down roughly another:
$8,000 of mortgage principal during the first year (we call it forced savings).
So Buyer 1 who originally invested only about $24,000 as a down payment, could have approximately $72,000 in home equity after one year, assuming the home appreciated as projected.
Meanwhile, Buyer 2, who waited to buy:
Paid $33,000 in rent
Missed approximately $40,000 of potential appreciation
Missed approximately $8,000 of principal reduction
Now has to pay $40,000 more for the same house
That's approximately $81,000 between rent paid and potential wealth-building opportunity during that one year. And that does not include the tax write offs for mortgage interest and property taxes.
Although the entire $81,000 is not a direct financial “loss” because a homeowner also has mortgage interest, property taxes, insurance, PMI and maintenance expenses,
It illustrates something very important:
PMI Shouldn't Be the Only Number Buyers Ought To Consider
Paying a few hundred dollars per month temporarily for mortgage insurance may sometimes make more financial sense than spending another year renting while trying to reach a 20% down payment.
And PMI doesn't necessarily last forever. Depending on the loan and the home's equity position, conventional mortgage insurance may eventually be removed.
Homeowners may also receive certain mortgage-interest and property-tax benefits depending on their individual tax circumstances.
Of course, no one can guarantee that a home will appreciate 5% next year—or that mortgage rates will remain unchanged.
That's why this isn't about predicting the market.
It's about looking at the entire financial picture rather than focusing on one expense.
For someone who has good credit, stable income, adequate reserves and expects to remain in the home for several years, buying sooner with a smaller down payment can sometimes make considerably more sense than waiting for the “perfect” 20% down payment.
The question I encourage buyers to ask isn't simply:
“How much will PMI cost me?”
It's:
“What will waiting cost me?”
Call me today (310) 519-7670 before deciding whether you should buy now or continue saving. I'm happy to run the numbers with you and can introduce you to some great lenders. Sometimes seeing the two scenarios side-by-side makes the decision much clearer.