You might say we were pretty hardcore when it came to paying off our student debt. We lived extremely frugally, made significant sacrifices, and worked hard to pay off that debt in a hurry.
With such an extreme approach to debt payoff, many were surprised that we bought a house so soon after becoming debt-free. Particularly, readers were surprised that we purchased a home without having 20% down.
Anyone who knows anything about buying a house knows that without a 20% down payment you have to pay private mortgage insurance (PMI). Understandably, your lender is taking a bigger risk when you don’t have much invested in the house yourself.
When we bought our first house we made a 20% down payment and got a 15-year mortgage. That was a fantastic financial move, and we would have loved to replicate it this time around, but for several reasons, we chose to buy with just 5% down instead. In order of least to greatest importance, here are many of the factors that influenced our decision.
I’ll be the first to admit that we were a little impatient to find our own place after living in my in-laws basement for nearly 4.5 years. That’s not to say that we didn’t enjoy and appreciate our time there, just that we were ready to move on.
However, my husband and I are both careful decision-makers. We wouldn’t make a huge decision like buying a house (aka becoming six figures under again) just because we were feeling impatient.
Along the lines of impatience, houses in California are expensive. While saving up a 20% down payment is entirely possible, it would take a long time. At a purchase price in our range of about $400,000, our down payment would have been $80,000. That’s not too far from the total cost of our home in the Midwest!
We figured that if we stayed in the basement with the same frugal lifestyle of our debt repayment and kept our side gigs going strong, we could save a 20% down payment in just under two years.
Obviously we’ve done hard things before and we’ll do them again, but neither of us wanted to take on another extreme financial goal. Paying off all that debt in a hurry was a little exhausting! Two years more sounded overwhelming.
One of the main reasons for putting at least 20% down on a house is to avoid having a mortgage insurance payment tacked onto what you’re already paying in principal and interest. As it turned out, PMI wasn’t as ridiculous as we thought it might be, thanks to our credit scores.
We pay $123 per month in PMI. This is, of course, still real money, but for us it’s worth it.
Side note: Because we got a conventional loan, we will be able to get rid of PMI once we reach 20% equity in the home. Had we gotten an FHA loan we would have to refinance in order to stop paying PMI, which would also leave us at the mercy of whatever the current rates might be (see why we chose a conventional loan over FHA and USDA).
Mortgage rates were beautifully low in 2016. They really couldn’t get much lower. At the beginning of 2017, after the presidential inauguration, rates were expected to increase.
Waiting a couple of years to buy would leave a lot of room for rate changes. It’s possible that in two years rates could be lower (or similar), but they could also be much higher. Hopefully we never see 18% mortgages again, like in the 1980s, but there was a lot of uncertainty about how much the new presidency and the world economy could increase rates. The only thing we were sure of was that the rates at the end of 2016 were some of the lowest we had seen in decades. Whatever happened in the future, we could be comfortable with the rate that we locked in when we made an offer on our house.
Let me give a numerical example of the effect the interest rate can have (using nice round numbers that are similar to our real numbers):
On a $400,000 house with 5% down (a loan amount of $380,000) and a 4.25% interest rate, we would have a monthly mortgage payment of $1,869 and a total cost of $672,974 over the life of the loan.
If we lived super frugally and saved up 20% down, but the interest rate went up 1.5%, the scenario would look like this:
On a $400,000 house with 20% down (a loan of $320,000) and a 5.75% interest rate, we would have a monthly payment $1,867 and a total cost of $672,276.
We can’t see the future and don’t know what interest rates will look like in two or three years, but seeing that an increase of 1.5% in the interest rate results in the same monthly payment and total loan cost (even after paying 20% down) is sobering. If the rate were to increase more than 1.5% during the time we were saving our larger down payment, our mortgage payment would actually be larger than it is now with just 5% down!
Finding the right house
While we were actively looking for a house, we weren’t sure we would find one that fit what we were looking for that was in both the price range and location we wanted. Getting the house, property, price, and location to all fall in our desired range seemed an impossible task.
When we did find it, it wasn’t at all how we had expected.
The house had come up in our online search months before, but the pictures were less than impressive (actually, awful) and there were some immediate turnoffs. We had essentially crossed the house off our list. Then one Saturday morning, when we had promised the kids we would go look at potential houses, an appointment with our realtor fell through. We quickly searched for something we could go look at, since the kids were primed. They had even made up little forms they could fill out that listed the things they liked and disliked about the house and property. Without many other options, we decided to attend an open house for the place that would become our home.
As it turned out we loved the house! The unstaged pictures in bad lighting were not an accurate reflection of the home’s potential. Anything that was a turnoff online was easily overlooked in person. The house, property, price and location were all great. Our home inspector even commented on our great find. As a bonus, the price had been significantly reduced when poor marketing by the realtor resulted in a general lack of interest (like our initially crossing it off our list.) For many reasons, we decided it was a house that we could love, something we hadn’t seen much of in our price, size, condition, and location requirements.
In the end
While we definitely see the value in making a 20% down payment, this time our situation worked out differently. It’s possible that a few years down the road we look back at and see that interest rates haven’t gone up, home prices have gone down, and waiting would have increased the economic efficiency of our home purchase. That’s okay. As I explained above, only some of our reasons were financial.
In the end we are happy (ecstatic!) with our house, payment and all. Whether it was the best financial move only time will tell.
Still, we’re planning to pay down the principal sooner than the normal schedule outlines so that we can get rid of the PMI (and hurry along the life of the loan). We’ll keep you updated on our progress!
How about you?
- Did you buy a home with less than 20% down? What was your reasoning?
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