Buying home now with low down payment could save money later

It’s a common misconception that a 20 percent down payment is required to buy a home. Advice to wait and save a large down payment is often based on the theory that the cost of mortgage insurance (known as MI), which is required when you buy with a smaller down payment, should be avoided.

This may not be the best advice and is, in fact, not in line with market trends, considering that 60 percent of homebuyers buy with a down payment of 6 percent or less, according to the National Association of Realtors.

You can qualify for a conventional mortgage with a down payment as small as 3 percent of the purchase price. It is also true that you can reduce your monthly mortgage payment by paying for discount points at closing, but that can be 5 or 10 percent of the purchase price — not 20.

Because every buyer’s situation is unique, it’s important to do the math. In today’s market, it could take a family that’s earning the national median income as much as 20 years to save a 20 percent down payment, according to calculations by U.S. Mortgage Insurers using a methodology developed by the Center for Responsible Lending. A lot can change during that 20 years, both in the family’s personal finances and in overall mortgage market trends.

How can buying a home now save you money later?

Let’s say you want to purchase a home that costs $235,000. A 5 percent down payment would be $11,750, versus $47,000 for 20 percent down. If you have a 740 credit score, at today’s MI rates, your monthly MI payment would be about $110, which is added to your monthly mortgage payment until MI cancels. MI typically cancels after five years; therefore, you will only have this added cost for a short period of time versus waiting an average of 20 years to save for 20 percent.

With home-price appreciation, today’s $235,000 home will likely cost more in the years ahead, and this will also have an impact on the necessary down payment — and the length of time required to save for it.

There are other variables in the equation too, such as interest rates. As federal rates rise, so too can the costs associated with financing a mortgage. The savings a borrower might calculate today could be altogether negated by waiting even a few more years. Another factor is that residential rental rates are on the rise across the nation, leading to a reduced capacity for many would-be homebuyers to save for larger down payments.

If you decide to buy a home today with a low-down-payment mortgage option, it is true that MI is an added cost on top of mortgage principal and interest — but keep in mind that MI is temporary, and it goes away, typically in about five years. Private MI can be canceled once a homeowner builds approximately 20 percent equity in the home through payments or appreciation and automatically terminates for most borrowers once he or she reaches 22 percent equity. When MI is canceled, the monthly mortgage bill goes down. It’s important to note that the insurance premiums on an FHA mortgage — the 100 percent taxpayer-backed government version of mortgage insurance — cannot be canceled for the vast majority of borrowers with FHA mortgages. So, do the math, and let the numbers guide you. There are many online mortgage calculators that can help. Check out www.lowdownpaymentfacts.org to learn more.