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Can’t Put 20% Down?

Let’s be honest, we’re all in the game of how can we save money, where can we save money, what can we save money on. This is especially important when buying a house. While a house will save you money down the road (building equity instead of essentially throwing money out the door on rent), there are quite a few additional costs to consider. Avoiding unnecessary costs can save you money in the moment and down the road. 

Putting 20% down on a house is typically the best rule of thumb. However, we do understand that this isn’t feasible for most. We’ve broken down three options you can choose from when you’re unable to put 20% down or aren’t sure if you should. 


Strategy #1 – Put 20% Down

First of all, easier said than done. Of course not everyone has the ability to save up for a 20% down payment, and doing this may push back the dream of homeownership a number of years. The nation’s savings rate is somewhere around 8% right now — higher than in recent history. Still, the time it would take to save up 20% for a down payment can be substantial.

Say a consumer is looking to purchase a $200,000 home and has already saved up $10,000. If the consumer is able to put away $500 a month toward the down payment, it will take five years to save up the additional $30,000 — perhaps a little less, depending on the rate of return on savings.

In that same time, at a below-average appreciation rate of 2% per year, the home’s value and purchase price has increased to $220,000, meaning the 20% down payment is now actually $44,000.

Plus, interest rates are changing daily and yearly. You’ll never know what your interest rate will be until you’re ready to lock one in.

Had the consumer put 5% down and used private mortgage insurance (PMI), she or he would have:

  • Been able to enjoy the home over the last 5 years
  • Built up more than $45,000 in home equity
  • Possibly been able to cancel mortgage insurance — right about the time he or she would otherwise be looking to purchase with a full 20% down payment and without mortgage insurance


Strategy #2 – Use a Piggyback Loan

You may be wondering what a piggyback loan is. Also called a “purchase money second mortgage,” a piggyback loan is used by homebuyers with less than 20 percent down to avoid paying private mortgage insurance (PMI).

A piggyback loan occurs when a borrower takes out two loans simultaneously: one for 80 percent of a home’s value, and the other to make up for whatever cash is lacking to make up a 20 percent down payment. This is used as an alternative to private mortgage insurance. A piggyback loan is also known as a second trust loan.

The most common type of piggyback loan is an 80/10/10 where a first mortgage is taken out for 80 percent of the home’s value, a down payment of 10 percent is made and another 10 percent is financed in a second trust loan at a higher interest rate. In some cases, you may even qualify for a piggyback loan with as little as a 5 percent down payment (known as an 80/15/5).

Piggyback loans eliminate the need for PMI. You combine this loan with your down payment to reach the 20 percent down needed for a conventional mortgage. This can significantly lower the interest rate of your mortgage. Another benefit of a piggyback loan is that the interest may be tax-deductible, potentially saving you even more money. 


Strategy #3 – Finance through FHA

FHA is a good program and plays a vital role in the mortgage industry. 

In today’s market, FHA loans often receive a lower interest rate than conventional loans financed with private mortgage insurance, commonly known as PMI. However, the mortgage insurance premiums (MIP) on 30-year FHA loans are almost always higher than private mortgage insurance premiums.

FHA charges an up-front premium that homebuyers pay at closing or finance into their loan amount and increase their debt. FHA’s minimum down payment amount is 3.5%. Currently the up-front premium is 1.75%. By financing the premium, the homebuyers essentially cut their down payment in half.

Private mortgage insurance offers premium options, many of which do not include any up-front premiums, minimizing the amount of cash needed to close.

FHA’s premium is usually priced higher than private mortgage insurance, meaning the homebuyers will pay more— often much more — using FHA mortgage insurance. And, unless they put at least 10% down, their monthly mortgage insurance payment cannot be cancelled, unlike private mortgage insurance.

Again, this is not to say that FHA is bad. It isn’t. It is an option that helps many families each year buy a home, which is wonderful. However it is still mortgage insurance, and in most cases, if homebuyers are able to go with conventional financing, the better off they will be.

It’s important for us to be transparent with our clients and prospective clients and make it known what their options are. We are always here if you have questions about what the best option for you might be.

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