By: Jenny Zhang
With so many home loan options out there, it’s easy for a first-time buyer to feel overwhelmed. Traditionally, the often-repeated phrase is to save 20 percent before buying your first home. But with loans such as the FHA loan offering as low as 3.5 percent down, is 20 percent still necessary? Even conventional loans like the 30-year fixed only ask for a minimum of 5 percent. So what’s the benefit of saving the entire 20 percent?
Saving for a Down Payment: The Benefits of 20 Percent Down
Putting down a hefty 20 percent on your home will save you from private mortgage insurance (PMI), or the insurance you’re required to pay to protect the lender in case you default on your loan. Avoiding PMI can add up to relatively large savings!
If you’re getting an FHA loan, you won’t have PMI. Instead, the mortgage insurance premium (MIP) is built into the monthly payments, as well as an up-front, one-time MIP payment at closing. The monthly MIP goes away after five years and after the loan-to-value of your mortgage reaches 78 percent of the initial sales price or the appraised price of your home (see Bankrate’s explanation).
If you have 20 percent saved already and you need a 30-year loan, you should look into conventional loans because 30-year fixed FHA loans still require MIP. On the other hand, if you only need a 15-year loan, 15-year FHA loans do not require MIP with 20 percent down.
Should You Save a 20 Percent Down Payment?
I didn’t. With all the financial benefits to having that 20 percent down, you might ask why not? The truth is, there’s a cost to waiting. I bought my house about two months ago and I rushed. By waiting, I would’ve gotten a much higher mortgage rate most likely), and I could’ve missed out on the first-time home buyer tax credit. Missing the credit alone would’ve cost me $8,000, not to mention the higher interest rate.
For me to save the 20 percent, I would’ve needed at least five years. And in that time, I would have been throwing money away on rent rather than building equity. While this varies by your income and spending habits, it was difficult for me to save a ton of money, and pay rent and all the existing bills at the same time. So, I went for it. I bought a home that was worth $120,000 just three years ago for $68,000.
Using the tax credit, I got all new appliances and remodeled the kitchen with new cabinets and granite countertops. So what about the MIP I’m paying? Well, I admit wholeheartedly that not having that would save quite a bit of money. But I calculated my opportunity cost, and in the end it made more sense for me to act now.
Buying a Home in a Buyer’s Market
While the 20 percent rule is still a great way to plan for buying a home, it’s also important to consider the market. To miss a buyer’s market like we’re in now so that you’ll have the full amount during a seller’s market may cost you more in the long-run. Of course, every situation is different, so be sure to figure out the costs specific to your needs. For me, the tax credit combined with low property values and low mortgage rates all made NOW the best time to buy a home for my situation.
For more tips about your home, money and credit, plus free tools to help you make the most of them – including a free credit score, home value estimate and home loan recommendations – check out Quizzle.com.
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This article was originally featured on Quicken Loans Mortgage News, where personal finance writer, Jenny Zhang, specializes in writing about home buying, refinancing and money saving tips.
