THE EFFECT OF SAVING UP MORE DOWN PAYMENT

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Lots of people think you need 20% down to buy a home.  Not true.  10% loans are everywhere.  FHA loans (loan limits in the low 400k range) are everywhere.  Let's just take a short example of a 10% loan.  There are 2 ways to get the below 20% loan. 

One is to take out a regular 80% loan and then get a 10% "piggyback" which is a smaller loan at a slightly higher interest rate.  The other is to take a 90% loan and pay for Private Mortgage Insurance (PMI).  PMI feels a little like buying fire insurance for your neighbor's house.  You are paying for insurance for the lender in case you default so they don't lose any money.  I know.  A little bizarre, but it's the way it works. 

Which one of these types of loans you take really depends on how long you're going to have the loan.  If it's going to be for only a few years, the option of taking the 10% with a piggyback is good.  You have a higher interest rate on part of the loan, but you escape it in a few years.  If you are going to hold the loan for a while, the PMI route is likely cheaper.  Here's how the PMI route works out:

If you pay $2,200 per month in rent and then decide to buy a $500,000 home...

Your payment jumps to $2,975 a month.  That's $35,700 per year.  BUT, you will get back on your fed/state return about $7,350 in tax reductions per year.  That means you are really out about $30,150 per year in housing costs (which is about $2,512.50 per month - not much more than rent). 

Of that cost, your PMI payment is about $195 per month.  But wait!  Once you have 20% equity in the home, you cancel the PMI payment.  Let's say the home goes up 5% per year for two years (conservative estimate these days).  You started with 10% equity, you added another 10% in appreciation - you're at 20%!!!  Then your payment goes down $195 per month.  That is about $33,360 per year in housing costs.  Subtract the $7,350 in tax advantage leaves your annual housing costs at about $2,167 per month.  Yes.  That's less than the rent.

But Dave, I still want to save some more money.  I really want 20% down. 

OK.  Let's say it's going to take you 5 years (if it's less, say half that time, divide these figures in half) to save up the rest of your down payment.  Great.  And let's say over those five years, your $500,000 dream home appreciates 4% average per year (again, conservative).  Between the appreciation you don't get, the tax break you don't get, the equity build you don't get from paying off your loan (remember, the entire amount of the rent checks go into the pockets of the landlord, whereas some of your mortgage check goes in your pocket as you pay down the loan and build equity) you lose out on something big.  That something big is $171,313.  That's right.  Over five years the home went up $100,000 in value, you paid of $36,771 in principal, and you got over $34,000 in tax benefits.

Or you can continue renting.  Not only do you lose out on the $171,313 net worth increase, but you blew $132,000 in rent that's going nowhere of interest to you.  But it is kind of you to pay your landlord's mortgage, taxes and maintenance all the while allowing him to collect the tax breaks and appreciation.  Very kind.

This does not count the rise in interest rates.  If, over those five years, interest goes up to about 6% (which it very likely will) your payment goes up from the $2975 example to $3500 to cover the increase in interest rate (which you live with FOREVER, unlike PMI which is about a two-year deal) PLUS the increase in cost.

So, with 10% down now, you can live for about $2,167 per month within a year or two.  Or you can wait, save more money, and have a house payment of $3,500 after you've saved the rest of your down.

Obviously, these figures need to be done for each individual case - if you want your specific case done, call or write and I'll figure it out.

Waiting to make the move is very expensive.

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