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Why Waiting to Save a 20% Down Payment May Not Be the Right Move

Most first-time home buyers have heard that they can avoid paying mortgage insurance by putting 20% down payment. You might assume that waiting to save this amount before purchasing is best.

However, this is not always the case.

While not having to pay mortgage insurance is certainly ideal, it often comes at a cost that far outweighs its benefits. Real estate will continue to appreciate during the months or years that it will take you to save the 20% down payment. Once you finally have the sum saved, you’ll have missed out on home equity from the home’s increased value. Additionally, you’ll end up being faced with an even higher home price — and down payment.

Here’s an example of how this works.

Purchasing Now vs. Waiting to Save 20% Down Payment

The Scenario

The average sales price of a home in King County in the third quarter of 2018 was $787,329. Of course, for a first-time home buyer, a lower price point will be more realistic. For this example, we’ll assume that the sales price is $500,000. This is still a significant cost relative to other areas of the U.S., but very typical for first-time buyers in King County.

[Related: Can I Afford to Buy a Home in Seattle?]

Second, let’s assume that the purchasers are a couple and that they have a combined gross annual income of $140,000, or $11,666 a month.

We’ll imagine that the couple currently has 10% ($50,000) to put down, but has been advised by a friend to wait until they have 20% ($100,000) to avoid mortgage insurance.

If the couple brings home 65% of their gross income, they have $7,582 of net income each month for living expenses and savings. Let’s also assume that after rent, food, and other bills, they are able to save $1,500 a month (or $18,000 annually) with careful budgeting.

[Related: Is Rent Keeping You From Saving for a Down Payment? The Fed Has a Plan]

Should They Wait?

At this rate, the couple will need roughly 34 more months to save the remaining $50,000, which would allow them to buy with 20% down and avoid the mortgage insurance.

But what is the potential cost of waiting?

The average appreciation rate for real estate in King County has been 6.71% over the past 59 years. To be conservative for our example, though, we’ll assume a 5% rate of appreciation.¹  

A $500,000 home that appreciates at 5% annually will cost around $576,000 in the 34 months it takes for the couple to save the rest of the down payment.

This means that the couple will now need to save even more money for the down payment. 20% of $576,000 is not $100,000, but $115,200.

It also means that the couple has missed out on $76,000 in equity. They would have had it if they had bought the home 34 months ago. Their net equity would have grown at a rate of $2,235 a month.

Had our couple bought with only 10% down, they would have paid about $79 a month for mortgage insurance. This number is based on a 760 credit score, a $450,000 loan amount, a 30-year fixed mortgage, and a 10% down payment. In this case, they would have gained $2,235 in equity.

To summarize, the couple gave up over $2,200 a month in equity to avoid paying $79 a month in mortgage insurance.

[Related: Lenders Roll Out New Program for Easier Homeownership]

The Takeaways

This is just an example, and takes many assumptions into account. This example also overlooks variables such as the time value of money, potential future returns, principal reduction, etc.

In some scenarios, waiting to save a 20% down payment may be best. But in all scenarios, buyers should consider the potential costs of waiting to buy in an appreciating market before making that decision.

Examining these costs may prompt you to buy early, without a 20% down payment. Then you can refinance in a year or two when your home value and equity have increased.

For help determining which home loan makes most sense in your specific situation, contact us today. We’re happy to run the numbers, weigh the pros and cons, and help you forge a path ahead.

¹ Appreciation is not guaranteed, and can fluctuate from year to year. For this example, we are assuming that it’s conservatively positive, based on historical averages.

Featured image via Pixabay

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