Don't have a payment? You should rent, too.
Down payments are part of the home buying process. But if you don't have the cash in hand, you may be required to buy private mortgage insurance. That expense is going to add up. You might actually be better off renting.
Rachel Pita, a tenant at 349 Pleasant Street, a 200-unit apartment complex, sits on the front steps of her building as she attends a meeting of a group called 'Malden Tenants United' who are fighting to battle proposed rent increases in Malden, Massachusetts in this June 2012 file photo. If you don't have a down payment, however, renting may still be your best bet.
Jessica Rinaldi/Reuters
When a person arrives at the point in their life where they desire home ownership, that person often doesn鈥檛 have 20% of the cost of the house they鈥檙e eyeing.
In our area, for example, a nice, recently-built family home with several bedrooms will set you back at least $150,000. 20% of that is $30,000. For many people who are recent college graduates and are facing student loans, car loans, an entry-level salary, and the difficulty of adapting to adulthood, $30,000 in the bank seems like an imposing goal. In other areas, that amount can be quite a bit higher.
The itch for home ownership often comes from living in an apartment (or something similar) and realizing that the place is a little small for the family you want to have 鈥� and perhaps not the most family-friendly place, either. I remember the apartment building I lived in during my late college years. There were a few families there, but there were also apartments full of partying college students who would blast their music at two in the morning and sometimes party to excess. The police were called more than a few times (not on me, thankfully, but on my neighbors more than once).
That鈥檚 the situation a聽lot聽of people find themselves in. They鈥檙e realizing the value in finding a better place to live, but they don鈥檛 have the financial means. The solution, as promoted by their parents and relatives and countless publications and programs, is to go buy a home. That鈥檚 the American Dream, after all.
The problem is that聽if you don鈥檛 have enough money for a down payment, you鈥檙e going to lose a lot of money.
When you ask a bank for a home loan, they鈥檙e going to want to see that you鈥檙e serious about the loan. One way they do that is by asking for a down payment. They want to see that you have the financial stability to come up with 20% of the value of the home.
If you can鈥檛 do that, you look a little risky to the bank. They鈥檙e going to want some insurance against the possibility that you鈥檙e going to be unable to pay back this loan.聽It鈥檚 going to be up to you to pay for that insurance.
PMI 鈥� or private mortgage insurance 鈥� is required by most lenders for loans exceeding 80% of the value of a home. PMI can vary a lot, but it usually comes in at a cost of about 0.5% to 1% of the value of the home per year. So, if you鈥檙e borrowing to buy a $200,000 home, you鈥檒l be paying an extra $1,000 to $2,000 a year in PMI. Usually, that鈥檚 rolled into your monthly mortgage payment, so you鈥檇 be paying an extra $80 to $160 a month.
What do you get out of that? Nothing at all other than the 鈥減rivilege鈥� of being able to borrow without a down payment.
You don鈥檛 have to pay for PMI forever 鈥� just until you鈥檝e built up 20% equity in your home. Of course, if you鈥檙e borrowing the full amount and making minimum payments, you鈥檙e going to be paying the PMI for something around twelve years on a thirty year mortgage.
Your other option, of course, is to get a home equity loan to cover your down payment. So, you get a normal mortgage that covers 80% of the value of the home, and you get a home equity loan that covers whatever else you need. The only problem is that the home equity loan will likely have a higher interest rate and it will also have its own closing costs.
In either case,聽there鈥檚 a significant extra cost to buying a home when you don鈥檛 have a 20% down payment.聽The bank will lend the money to you, but it will cost you.
Don鈥檛 get tempted into diving into home ownership without a down payment. If you feel like you need a better place to live but you don鈥檛 have the down payment, look for a better rental situation. Don鈥檛 start diving into the real estate pages unless you have enough money in the bank to secure the best possible deal for yourself.