Why a minimum down payment of 20 percent is necessary
Many loan products in today's marketplace offer as low as 0% down when purchasing a home. For conventional loans, typically the buyer is required to put at least 5% down. Regardless, using anything below 20% as a down payment when shopping for homes is a big mistake.
The 20% Rule
Generally speaking, a 20% down payment should be the norm when purchasing your home. Here are some reasons to put as much as possible down on a home:
These are some of the most noteworthy reasons to put 20% down on a home. Mortgage interest write offs are a thing of the past and should not be a reason to borrow more money. Remember, large interest payments are the enemy of debt elimination. Having significant amounts of interest is indicative of high principal balance that is ultimately still owed. This is never a good thing for those on the path to financial independence.
However, there is still an even bigger reason to put 20% down on a home.
The single biggest reason to put 20% down payment
The most significant reason to put 20% down on a home is to keep you honest with your home search. If you stay within a price of homes that still permits a comfortable 20% down payment, it will prevent you from living above your means. Using 20% down is a an excellent way to figure out how much house you can truly afford.
As a general rule of thumb, I still like to have 6 months worth of savings in an emergency fund along with at least $2,500 in my checking account after making a down payment and closing costs. Working backwards to figure out how much you need saved would look something like this:
For example, say you have $3,000 a month in expenses and you are seeking to purchase a home below $275,000. Using the equation above, we can find out the minimum amount necessary to fund the purchase of a $275,000 home.
I would suggest that you never expect to use your emergency fund for anything related to a home purchase and closing costs. Do not earmark this money for anything except a true emergency. The extra $2,500 I recommend is to cover some minor expenses and repairs that you come across when moving into a home for the first time.
One look at the necessary minimum for purchasing a $275,000 home may leave you feeling like this is unattainable. If this is the case, you have two options. Option A is to lower your desired purchase price. Option B is to save up for longer because you are not ready to purchase this much home.
The safeguards of 20% down
Using the 20% rule as a metric for determining how much house you can afford would prevent the most common financial mistake of homebuyers, purchasing too much home. Further, by saving the necessary minimum amount highlighted in the equation above, you prove to yourself that you are financially prepared to make the largest purchasing decision of your life.
Be careful about listening to the advisement of those urging you to put no money down or using bizarre mortgage products such as interest only loans. Saving and preparing financially for a home purchase can be simple and straightforward, whereas using a more advanced strategy like an interest only loan or a 0% down payment can be costly and complex long-term. Nothing is more devastating in personal finance than debt and a mortgage will likely be the largest loan you will ever incur. Do not be afraid to purchase a home, but first make sure you are truly financially prepared by using the tips found above.