How much do you need for a deposit?
A reader asks:
I’m a 33 year old film producer in Los Angeles and have my own business, so no stable salary, but it’s safe to assume I’ll make between $40,000 and $150,0000 (impossible to predict). I currently have $125,000 (70% stock, 30% cash). Personal finances are healthy (no kids, no debts). I am currently a tenant and I have a roommate and it sucks. My goal is to get a house by mid-2023 in the valley, preferably sooner. Most homes cost between $650,000 and $850,000. I have two questions:
Should I put myself in a bigger cash position since I want to spend the money soon? What is a good report?
Should I wait until I have a sufficient deposit or go when I have found the right place? Is it better to save for a nice big down payment since my annual income varies?
The assumption most people have when going through this process is that you need a minimum of 20% down payment when buying a home.
There are certain advantages to having a 20% down payment.
It’s less debt to take on. This gives you an equity cushion in case the slot goes down the toilet for a while. And it saves you from paying for private mortgage insurance (PMI) which can cost you between $75 and $150/month depending on the size of your mortgage.
I understand why many homeowners would want that 20% down payment before buying.
But this is not a prerequisite.
According to a research report by National Association of RealtorsHere’s what the median installment numbers look like overall and in different age brackets:
The median down payment is 12%, but you can see it’s much lower for people in their 20s (6%) and 30s (10%).
This makes sense considering that seniors have more financial assets or equity in their current home to fund a larger down payment.
The median sale price of an existing home in the United States is now over $350,000:
You can see that the majority of down payments for people in their 20s and 30s come directly from savings:
Here are the down payments at various times for a $354,300 home:
- 5% – $17,000
- 10% – $35,000
- 15% – $53,000
- 20% – $71,000
If you’ve saved for 5 years for a home at this price, that’s almost $1,200/month for a 20% down payment. Not everyone can afford to save $1,200/month for 5 years for the luxury of buying a home.
A 20% down payment on a home in the $650,000 to $850,000 range is $130,000 to $170,000.
The down payment we made on our first home was only 5%.
And it’s not like we’re trying to use as much leverage as possible. That’s all we could afford to move into a house at that time. It would have taken us years to get to 20%.
There are options for youngsters who don’t want to live on ramen noodles every night just so they can save up for a down payment.
An FHA loan just requires a down payment of as little as 3.5%.
Now, some people scoff at that number and say that FHA loans are rare. These are certainly not the most popular loans. Here is the breakdown by type of loan:
It seems that one in five homebuyers in their 20s or 30s are able to get one of these loans. It would be nice if that number was higher, but it’s not out of the question.
This question probably depends mainly on the lender you choose and your credit score and financial situation. The NAR has a list of reasons people get turned down on a mortgage application:
It’s actually quite rare to have an application turned down, but the number one reason is a low debt-to-income ratio.
This is good news for the reader who asked this question. They hold no debt. The variable income component may show up in the application process, but that’s why I would suggest shopping around for a number of different lenders.
The internet makes it much easier to compare rates, fees, etc. Beyond banks, you can also check out credit unions and online lending platforms.
Here is what I would do in this situation:
Shop around to find a lender. See what type of down payment they are looking for. See how much money they are willing to lend you. See what type of mortgage you’re getting pre-approved for.
And if your variable income is an issue, at least you know you might need a bigger down payment.
Determine how much payment you can manage based on certain installments. The down payment is important to start with, but the only thing that really matters is your ability to meet the monthly payments, taxes, insurance and maintenance associated with home ownership.
Start looking for houses. The process can take longer than expected, especially with such a low supply these days. I’d be more concerned with finding a home than reaching some mythical down payment goal.
You can still prepay your mortgage if you go below the 20% down payment threshold to exit the PMI payment.
The thing I wouldn’t do is try to time the housing market waiting for prices to come down or a recession or some other macroeconomic event.
Buy a house because you like it, can afford it, can pay off your debt, and want to live in it for years to come.
We talked about this issue in this week’s Portfolio Rescue:
I also had Blair duQuesnay back to answer some questions about 529 employee stock plans and options.
And if you prefer to listen to this episode as a podcast see here:
What should a first-time home buyer do now?