It’s surprising how many mortgage and financial professionals are still advocating a 20% down payment. It’s bad advice and lazy thinking, as we’ll make clear.
The Old Argument: Don’t buy a home unless you can put down 20%
It’s true that putting down 20% will shield you from mortgage insurance most of the time (some loans will still require mortgage insurance). Also, the mortgage will be smaller (since you put more down), so the mortgage payment will be smaller.
But most people don’t have 20% to put down. Not even close. That is a $40,000 down payment for a $200,000 home (which is considered “small” in Utah and Salt Lake Counties).
The Better Argument: Delaying homeownership until you have a 20% down payment is a waste of time and money
The crux of this argument is Net Worth, at least as it relates to housing. The non-technical definition of net worth is how much cash you would have if you sold all of your assets and paid off all of the associated debts. Let’s compare the net worth of two couples, one who put down 3.5% and bought a home now (we’ll call them the Flanders) and a couple that waited until they had a 20% down payment (we’ll call them the Wiggums).
First, a few assumptions:
Both couples want/need a $200,000 home.
The cost of renting is roughly equal to a mortgage payment for the same home (this is true, in today’s market).
Homes in Utah appreciate 5% per year (a conservative average for the last 5 years).
Both couples have $7500 saved now and can/will save another $6500 per year for the next 5 years.
The Flanders (3.5% down) –
The Flanders have enough to put down 3.5% on a $200,000 home right now ($7500). They buy the home and live in it for 5 years.
After 5 years, the mortgage balance is down to about $175,000 and the home is worth about $255,000.
They sell the home, pay off the mortgage, and walk with $80,000.
They’ve also saved $6500/year for the last 5 years, giving them another $32,500. The Flanders’ net worth is $112,500.
The Wiggums (20% down) –
The Wiggums can’t put down 20% now (and won’t be convinced otherwise), so they save for 5 years, renting the entire time.
After 5 years, they buy a home, putting down $40,000. For comparison’s sake, they sell the home the next month.
Their mortgage balance is $160,000 and the home is worth about $200,000 (they just bought it), so they walk with $40,000.
The $6500/year they saved went towards the down payment, so the Wiggums net worth is just $40,000.
Each couple spent the same amount for housing, savings, etc., but the Flanders have almost $80,000 more than the Wiggums. Plus, since the Wiggums waited 5 years to buy a home, rates would likely be higher and the home that cost $200,000 at first now costs $255,000 (because of 5% annual appreciation)!
There are exceptions that could affect this analysis (sudden market crash, super cheap rent compared to mortgage payments), but even accounting for those, it is almost always better to buy as soon as it is feasible.
There are few no-brainers in the financial world. This is one of them. It makes NO sense to forego homeownership until you have a 20% down payment!
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