Purchasing a new home can be daunting. Most buyers, particularly first time buyers, are concerned about the financial aftermath of making such an expensive purchase. This fear holds true for making the initial down payment as well as for eventually paying the mortgage. Fears over down payments and mortgages come from two different sources of worry. Mortgages are a long term concern, and their saving grace (if any really exists) is that they can be planned for. Buyers who want to plan out their lives will consider the effect of their mortgage on their five-year employment prospects or weigh the cost against other obligations. Down payments are a different animal in that they raise short term financial concerns. Down payments are often a massive investment for most home buyers. Assuming the value of the home is $200,000, a 20% down payment would equal $40,000, which is not easy for most middle-class families to afford.
Given the realities of family finances and the price of real estate, home buyers and particularly first-time home buyers are turning to lower cost down payments. Not only are lower cost down payments easier to afford, they may not be crippling in the long run if the buyer plans properly. This article examines the pros and cons of low down payments when buying a home. The hope is that these tips will better educate homebuyers, especially first-time buyers.
Financial Cost-Benefit Ratio – Playing the Long Game
The simple question of down payments versus long term mortgages can be summed up simply as: “how much do you want to pay and when?” Long term mortgages and down payments sit on a sliding scale. The larger the down payment, the lower future mortgage payments will be, and the lower the down payment, the larger future mortgage payments will be. While the conventional down payment is 20%, this scale is adjustable to a large degree. Most financial lending institutions will accommodate varying ratios of down payments. Thus, deciding whether to purchase a home with a lower down payment versus a higher down payment is simply asking the question of how much should be paid and when. Given these realities, a lower down payment may be a good idea for type-A planners who can better manage the long-term realities of making mortgage payments on the higher end.
There are some distinct advantages to lower down payment purchases. Low cost down payments often come with lower long term mortgage interest rates. While it is true that lower interest rates are essentially an advertising ploy, there are still strong benefits. Let’s compare two different sales of $200,000 homes, a conventional sale and a low cost down payment sale. To make the math simple, let’s assume that the conventional sale results in a 20% down payment ($40,000) with a 5% interest rate on the mortgage paid off over 30 years. This conventional sale results in an average monthly payment of $859, which includes only principal and interest. To compare the lower down payment sale, let’s assume a 5% down payment with a 4% interest rate on the mortgage paid off over 30 years. This low down payment sale results in an average monthly payment of $907. In the low cost down payment scenario, the bank will get roughly $20,000 more over the lifetime of the mortgage, but that may not be terrible for the average planner. After all, the monthly difference is only $48 and the home buyer had to pay $30,000 less upfront. For short-term planners, this low cost down payment model could be beneficial immediately, and may also not be too off-putting for long-term planners. For long-term thinkers who are also investors, having an extra $30,000 to invest is also not a bad result.
Availability of Low Cost Down Payment Assistance
First-time homebuyers may also have access to down payment assistance programs which could either completely cover or substantially mitigate the cost of a lower down payment. There are many forms of down payment assistance, and most work similarly to grants in that they do not require repayment. The Department of Housing and Urban Development’s website includes advice on seeking assistance with down payments and resources for first-time homebuyers. Down payment assistance programs are also widely available to most first-time homebuyers. While it is true that these programs are often limited by geography, income, or other metrics, there are so many down payment assistance programs in existence that most homes and most homebuyers will be eligible for some form of assistance.
The Benefits of Alternative Forms of Financing
Potential homebuyers can also take advantage of the low-cost nature of lower down payments and use unconventional financing means to front the money for a down payment. It is not uncommon for potential homebuyers to receive a small inheritance, win a legal judgment or settlement, or be gifted enough money to make a low cost down payment. For people with sudden immediate access to collateral, a low cost mortgage may best suit their financial needs. That said, people receiving such sudden sums should be cautious about immediately sinking money into a home. Buying a home is a major investment and should not be taken lightly. Make sure that the monthly mortgage payments are also manageable long term.
Buying a home is one of the most exciting purchases that anyone can make. The American dream is built on home ownership, and everyone should have the opportunity to own their dream home. For some, a low cost down payment mortgage may be the smartest way to make that happen. For others, the long-term costs may outweigh the short term benefits. If you are considering purchasing a new home in either New York or New Jersey, Law Office of Yuriy Moshes provides assistance and advice to clients seeking to purchase their dream homes. If you would like legal representation during the home buying process or would like an attorney to review your purchase contract or loan documents, call our law firm and we will schedule a consultation for you.