Down payments are so tricky that a real estate bubble is brewing

This is a particularly important question in a context of skepticism about the continuation of the record appreciation of prices in the real estate market. (Example: A recent report from the Dallas Federal Reserve indicates that there are signs of a housing bubble in the United States.)

On the other hand, less cash-hungry borrowers may wonder how low a down payment is in this environment. Even if they are able to win the contract with a lower down payment, they will face a higher monthly mortgage bill at higher interest rates, in addition to paying for private mortgage insurance if they pay less than 20% down payment.

Here’s a quick recap of how down payments and mortgages work: Some loan programs allow eligible buyers to put down as little as 3% down. With any down payment less than 20% of the purchase price of the home, a bank will typically require the buyer to purchase private mortgage insurance as part of the monthly expense to offset the higher risk the bank is assuming.

So let’s first consider the pros and cons of a down payment of more than 20% – which is even more likely now that many homeowners will reap big gains from the sale of a previous home. My advice would be to go for it, provided you can afford it and really want the house. Consider this: Putting more than 20% down increases the competitiveness of an offer by 31%, according to Daryl Fairweather, chief economist at Redfin.

A larger down payment is particularly attractive to sellers these days due to valuation issues. Appraisals are generally based on comparable sales from two or three months ago and may not reflect current home values ​​in some markets. Given the intense competition, homes are sometimes priced below what buyers are offering to pay. The extra down payment can act as a buffer to make up the difference and give you an edge over someone offering to put down less money.

Now, if you’re worried about falling too low and housing prices crashing, remember that while demand may eventually subside following out-of-reach rate and price increases, supply should stay tight. This may lead to more moderate price increases, but not an actual drop. And as the Dallas Fed report pointed out, household balance sheets are in better shape and there’s no excessive borrowing, so it’s not 2007 again.

Besides saving interest over the term of a smaller loan, there are other benefits to making a larger down payment. For example, a borrower who puts down 20% and has a credit score of 700 may face a so-called risk-based fee of 1.25% of the loan amount, which could be incorporated into the interest rate charged, says Keith Gumbinger, vice president of mortgage website HSH.com. The fee drops to 0.5% when you pay a 30% deposit and disappears for a 40% deposit.

Yet even if they can afford it, young homebuyers might prefer to put more money in the stock market than tying it up in their homes, because over the long term, stock market returns are likely to outpace market appreciation. real estate prices, says Kevin Mahoney, a certified financial planner in Washington. Likewise, those who don’t plan on staying in their homes for very long may want to pack less.

For those worried about putting much less than 20% down, let me give you some perspective. Most people deposit less than 20%. The median down payment was 13% in 2021, according to the latest figures from the National Association of Realtors, which is consistent with what it has been for the past four years. Even for those who were repeat buyers, the median down payment was only 17%.

And yes, rates are rising, but they are still historically low. As long as you’ve worked out what your monthly payment will be and are comfortable with it, you shouldn’t let the fact that it might have been lower a year or two ago guide your decision to buy. buying a house today.

It is also important to maintain cash reserves instead of putting everything on deposit. First-time home buyers often underestimate how much they will need to spend on things like landscaping or window treatments, or unexpected repairs.

If you’re worried about the cost of private mortgage insurance with a bank loan, remember that after five years you can cancel it if you’ve reached 20% of your home’s equity (the difference between the current value of your home and how much you owe on your mortgage). If you reach 25% equity, you may be able to cancel after just two years. You could reach that faster than you think thanks to rising home values.

Much like the antiquated rule of thumb of not spending more than 30% of your income on rent, the guideline that you should only pay a 20% down payment – nothing more, nothing less – is not everything. just not very useful anymore.

More other writers at Bloomberg Opinion:

• Soaring mortgage rates won’t reverse house prices: Jonathan Levin

• Consumer despair is probably worse than we think: Jared Dillian

• A stronger housing market can withstand a hawkish Fed: Conor Sen

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Previously, she oversaw tax coverage for Bloomberg News.

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