Reasons Why Buying A Home With A Small Down Payment Can Be Good & Bad
One of the most frequently asked questions about mortgages relates to down payments. Just to give you an idea, some of the most common questions regarding down payments include;
- How much of a down payment will I need?
- What is a down payment?
- Are there programs available that allow a small down payment?
Buying a home with a small down payment can be done. There are actually many home buying programs that allow a buyer to purchase a home with little or no money. It’s extremely important to understand what buying a home with a small down payment may mean before deciding to go that route.
Below are some of the PROs and CONs to buying a home with a small down payment. If you’re contemplating the purchase of a home and are on the fence about whether to utilize a program that allows small down payments, make sure you realize what the potential benefits and drawbacks are.
What Is A Down Payment?
A down payment is a percentage of money that is required up front to purchase a home. A down payment is one of the most well known costs involved with buying a home.
The down payment will vary depending on the type of mortgage financing a buyer elects to use. As you’re preparing to buy a home, it’s important that you understand what a down payment is but also learn about some of the best tips for saving for a down payment.
Buyers who understand what a down payment is and know how to save for it generally don’t experience sticker shock when buying a home.
PROs Of Buying A Home With A Small Down Payment
Before deciding to take advantage of a mortgage product that allows a small down payment, you need to understand what the benefits of buying a home with a small down payment are. Read on to find out the PROs of buying a home with a small down payment.
Allows Buyers To Purchase A Home
One of the major reasons why lenders allow buyers to purchase a home with a small down payment, or even a zero down payment, aside from the lender getting the mortgage and the subsequent money they’ll make on it, is because some buyers don’t have boatloads of money saved. There are many potential buyers out there who have excellent credit and a great job history, but don’t have a ton of money saved up for a substantial down payment.
One of the biggest benefits to buying a home with a small down payment is it allows more buyers to buy a home, which in turn, allows more sellers to sell their home. Depending on the type of mortgage a buyer is obtaining, it’s also possible in addition to need little to no money down that a buyer may also receive seller concessions. Seller concessions in real estate allow a buyer to receive money from a seller to be used towards their down payment and closing expenses.
Without these small down payment programs, there would be significantly less buyers who are able to buy a home.
Doesn’t Drain A Buyers Savings Account
Another great benefit to buying a home with a small down payment is it allows buyers to not drain their savings account. One of the most important tips for first time home buyers that cannot be discussed enough is that there are costs associated with not only buying a home, but also owning a home.
Small down payment mortgage programs give buyers the ability to have money left after paying their down payment and closing expenses, should there be an emergency or a repair that is needed in the home.
For example, if you’re buying a home with a small down payment and you need to replace the furnace after closing unexpectedly, having money left in your savings account is huge. This is only one example of a home repair that can arise while owning a home, but there are many others.
CONs Of Buying A Home With A Small Down Payment
It’s human nature to not want to spend our hard earned dollars, but electing to buying a home with a small down payment may not be the best fit for your situation. It’s vital that before you decide to utilize a program that allows zero or little down, you understand what the potential drawbacks are. Read on to find out the CONs of buying a home with a small down payment.
Lack Of Immediate Equity
Owning a home is considered a solid investment opportunity due to the ability to build equity. Equity is defined as the difference between the current fair market value of a home and the amount a homeowner owes on a mortgage.
If you’re contemplating a zero down or small down payment mortgage program, you need to be aware that this may lead to a lack of immediate equity in your home. Lack of immediate equity is a drawback of buying a home with a small down payment. The larger a down payment, the greater the amount of instant equity and vice versa.
While it’s impossible to predict the future, if you’re planning on buying a home with a small down payment, you should be planning on staying in the home for more than 5 years. The reason staying in a home for at least 5 years when buying with a small down payment is because if you decide to sell beforehand, you may not have enough equity to cover the expenses to sell a home, unless you’re in a market that is seeing values appreciate quickly.
If you sell before you have enough equity in your home, you may potentially need to perform a short sale, which can be a very long, stressful, and unsuccessful process.
Buyers who are utilizing a small down payment mortgage product will be required to pay mortgage insurance monthly. Mortgage insurance is a specific amount of money that is paid each month or upfront by a borrower to a lender as a safeguard should the borrower default on their loan.
The added expense of mortgage insurance is one negative of buying a home with a small down payment. If you’re unable to produce a large enough down payment to eliminate mortgage insurance from the beginning of the term, it’s critical you know if, how, and when you can remove mortgage insurance.
Higher Interest Rates
Interest rates are very important regardless of what you’re going to be purchasing. Mortgage interest rates are arguably the most important however. The reason why mortgage interest rates are so important is due to the amount of money that is being borrowed.
One of the CONs to buying a home with a small down payment is the potential of higher interest rates. The reason interest rates for a buyer who is putting zero or little money down can be higher is due to the amount of risk the lender is taking on.
For example, it’s extremely likely that a buyer who is obtaining a minimum down FHA mortgage will have a higher rate than a buyer who is obtaining a 50% down conventional mortgage.
There are dozens of reasons to get pre-approved for a mortgage which is important before shopping for homes. Learning about the correlation of interest rates and down payment amounts is just one of the major reasons.
Higher Monthly Mortgage Payment
Buyers who utilize small down payment mortgage programs will face higher monthly mortgage payments than buyers who are able to put down more money. The higher monthly mortgage payment is another drawback to consider when buying a home with little to no down payment.
If you’re unsure why a smaller down payment results in a higher monthly payment, below is an example to illustrate how the down payment amount impacts payment. The example below is using a subject property that sold for $200,000, annual real estate taxes of $8,000, hazard insurance of $6.00 per thousand financed, and a mortgage interest rate of 4.0%. The two scenarios are both conventional mortgages. The only difference between the two scenarios is the down payment amount and that scenario 2 does not include mortgage insurance due to the down payment amount.
- Scenario 1 – 5% down payment – Monthly PITI (Principal, interest, taxes, and insurance) = $1,754.26
- Scenario 2 – 20% down payment – Monthly PITI (Principal, interest, and taxes) = $1,510.53
As you can see, the payment for scenario 2 is almost $250.00 less per month. Over the course of a 30 year mortgage, this is a substantial amount of money saved.
Weakens Negotiating Power & Loss Of Competitive Edge
If you’re going to be buying a home in a sellers market, you need to understand that utilizing a small down payment mortgage weakens your negotiating power and can result in losing your competitive edge. Weaker negotiating power and the loss of the competitive edge is another potential pitfall of buying a home with a small down payment.
In a sellers market there are more ready, willing, and able buyers who will be competing for a home. It’s highly likely that these competing buyers will have the ability to put more money down. A larger down payment from a buyer is better in the eyes of most sellers.
This means if you’re going to be taking advantage of a first time home buyer program or another type of product that allows a small down payment, you need to be aware that you may lose out on a home or two.
The amount of your down payment plays a huge role in the mortgage and home buying process. There are many reasons why small down payment programs exist, but they aren’t the best fit for everyone.
It’s critical that as you’re trying to figure out what type of mortgage is best for you, you understand the PROs and CONs to buying a home with a small down payment if you’re considering one of these mortgage products. The above PROs and CONs should help you make an educated decision.
If you’re still unsure, it’s highly suggested that you discuss all of your options with an experienced local mortgage professional or real estate professional.
Other Top Mortgage Resources
- 5 Things Real Estate Agents Don’t Know About Low Down Payment Mortgages via Mass Real Estate News
- Mistakes Made By People Who Buy A Home With Little Or No Money Down via Inlanta Mortgage
- Why Do Real Estate Agents Ask For Pre-Approval Letters Before Showing Homes?
Are you thinking about buying a home in Rochester NY with a small down payment? If so, it’s important that you evaluate the PROs and CONs to buying a home with a small down payment. If you don’t have a top Rochester NY real estate agent yet, contact me, and I’d love to discuss your individual situation in detail!
About the authors: The above article “PROs And CONs Of Buying A Home With A Small Down Payment” was provided by the Keith Hiscock Sold Team (Keith & Kyle Hiscock). With over 30 years combined experience, if you’re thinking of selling or buying, we’d love to share our knowledge and expertise.
We service the following Greater Rochester NY areas: Irondequoit, Webster, Penfield, Pittsford, Fairport, Brighton, Greece, Gates, Hilton, Brockport, Mendon, Henrietta, Perinton, Churchville, Scottsville, East Rochester, Rush, Honeoye Falls, Chili, and Victor NY.
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