Home Loan Choices

Home Loan Choices

Old rules are outdated . . . consider new options.

For decades, conventional wisdom dictated that home buyers make a down payment of at least 20 percent. Without those funds, buyers weren’t considered financially sound enough to invest in a home.

The traditional rationalization was that a good-sized down payment led to a lower interest rate, was a way to avoid paying for mortgage insurance, and resulted in a smaller monthly mortgage payment. In turn, the lower monthly payment allowed extra funds for home maintenance, home furnishing purchases, setting aside money in savings, or for the worst case scenario, job loss or a financial challenge due to a serious illness.

That was then. As home prices started to inch up like the temperature on a hot summer day–then soared–in the 1990s and early years before the Great Recession of 2008, many homeowners found they were unable to afford to plop down the 20 percent. And with that scenario, the conventional wisdom about down payments and home loans flew out the window–and door.

When the Recession hit, many homeowners who had purchased a home with a small down payment were also facing job loss or declining income, and found themselves facing a foreclosure or a short sale as their mortgage payments could not be managed. After record U.S. loan defaults and lender losses, loan underwriting standards were tightened and home loans suddenly became much tougher to get –and in some cases were unavailable.

Today’s there’s no one-size-fits all strategy regarding how much to put down when buying a home. Any decision should reflect a buyer’s budget needs and lifestyle rather than a generic response.

Some home buyers still opt to put down at least 20 percent or even more for the reasons mentioned. This cohort often includes empty nesters trading down and with equity in hand from a larger house sale, or perhaps from saved earnings from their jobs, retirement funds, or even inheritances.

Others, especially young professionals investing in their first home, aren’t so sure what the right amount to put down should be. They’re smart to discuss the pros and cons with a financial advisor as well as their mortgage lender or bank.

Here are some tips as to how best to proceed and reach a decision:

  • Get smart financially by reading up on living within a budget. One good resource that’s online is "360 Degrees of Financial Literacy."
  • Educate yourself about all the new products on the market, including Fannie Mae’s HomeReady® mortgage, which requires only 3 percent down and VA home loans for military veterans require no down payment.
  • Interview several mortgage professionals (at least three) and ask what loans they can offer based on your income and credit score. Remember that a mortgage payment is just part of the monthly cost. You also have to add in real estate taxes and escrow.
  • Consider keeping your housing costs to under 28 percent of your monthly gross income–what you earn before taxes. Housing costs comprise the mortgage payment, real estate taxes, homeowner’s insurance and mortgage insurance if you have less than 20% down payment.
  • Think about being even more conservative financially by keeping your mortgage payment and all other monthly debt payments–college loans and credit card debt–to under 43 percent of your gross income.
  • Know that it’s ok to factor in a second income for your gross income total, if you’re part of a two-career couple. In the past, many couples only used one income because so often one partner/spouse might stay home to care for a baby, they wanted a safety net if one or the other lost a job, and they also considered doing so as a way to force savings. These days more households are supported by two incomes.

With all information in hand, develop a spreadsheet online or take out a pencil and lined pad, and compute how different down payment scenarios will affect your monthly mortgage and housing costs. Juggle the numbers to come up with a plan that works best for you.

On a separate list, chart your financial wants and needs for the coming years and budget for that dream vacation, for your kids’ college accounts, for your own retirement, or a new car, bathroom remodel, and so on. These are real life expenses, so budget wisely.

The good news is that the housing market is steady again, there are many home price points now – even "Tiny Houses" for budget-wise buyers – and there are many home financing programs available today. You’re in the driver’s seat. Just make sure you’re comfortable with your budget and your monthly housing expenses. You want to reach your long term financial goals – and sleep well at night.