Should You Pay the Minimum Down Payment?
December 19, 2018 by Marty Orefice | Financing, Real Estate, Rent to Own
Option fees are typically between 2.5 percent and 5 percent of the cost of a home. That being said, today, you can get a mortgage with a 3 percent down payment through FHA loans.
So, if you can start building equity on your home today, why would you pay an option fee and rent to own for a few years instead?
While you might qualify for a mortgage today, that doesn't mean it's your best option to get one.
Why Some People Wait to Buy
In a recent CNBC article, David Bach, the co-founder of AE Wealth Management, recommends waiting until you have a 25 percent down payment before buying a home, but at least giving 20 percent to avoid paying PMI, which can cost you an additional 1 percent of your loan annually.
Still, 1 percent of your loan is likely less than what you'll pay in rent throughout your rent to own deal.
The real reason that you should wait to have a larger down payment before securing a mortgage is that your likelihood of success is higher.
When you're putting everything you have into a home purchase, you aren't left with anything in case the unexpected happens.
People who drain their savings on a down payment don't have anything extra for emergencies, like house repairs, car repairs or unexpected salary changes.
According to Bach, the majority of people who lost their homes during the Great Recession secured no-money-down loans or gave 5 percent down.
It's also important to recognize that your down payment isn't the entirety of what you'll need to spend right away. Closing costs can be a huge unexpected cost burden of home buying. The closing costs themselves can be 5 percent or more of the cost of your home.
What Should You Do?
Bach's strategy of paying a 25 percent down payment isn't necessary, but saving at least 20 percent is a good idea. To get to an amount that large, your finances will have to have been stable for a while. Meaning, that you've saved that amount over the ups and downs of sustained time, as opposed to a small amount which you may be able to save in a year.
A lot of people can save up 3-5 percent, but saving 25 percent is evidence that your savings strategy can weather unexpected circumstances. Plus, the larger your down payment, the lower your monthly payments are not just because of a smaller PMI, but also because of less interest to pay and a smaller principal balance. It's easier to meet smaller monthly payment during hard times than it is to meet larger ones.
The Rent to Own Option
Renting to own gives you a 2-3 year buffer. If you feel ready to buy now, it gives you the opportunity to make sure your savings plan is sustainable for a longer period of time. It's not just about faith in yourself, but also faith in the economy, health and more. You wouldn't want to enter the biggest investment of your life without being fully prepared.
Choosing to rent to own and save for a bigger down payment doesn't mean that you have to give up on a great property that's available now.
Many sellers aren't aware of how lease-options can benefit them. Explain the situation, and the seller of the home you're interested in might be willing to let you rent to own it instead. Your rent payments can help them pay down debts and the process is very likely to lead them to a sale of the home.
Plus, there are strategies buyers can employ that will help you save money for a larger down payment that are only available through rent to own.
One example is rent credits: a system in which a portion of your monthly rent payment goes into an escrow account for you to use toward your down payments. In some negotiations, the seller will match the contributions.
You can take advantage of opportunities like this one to save up a larger down payment, pay less in interest over time, potentially get a better interest rate and avoid paying PMI.
