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Experts say saving up 20% for a home could backfire, but there are a few smart things you can do instead

  • Saving 20% for a down payment is a dream for many; it means you’ll avoid private mortgage insurance.
  • But with home values rising and savings accounts earning low interest, saving 20% may not be wise.
  • Instead, get into the market now with a smaller down payment and let your home’s value appreciate.
  • Read more stories from Personal Finance Insider.

If you’re working hard to save up a 20% down payment for your dream home, there are numerous economic factors standing in your way. You may not be saving fast enough to make any progress, according to a recent report from the National Association of Realtors. In fact, their stats show the median sales price of single-family existing homes rose 22.9% to $357,900 over a one-year period from August 2020 to August 2021. 

Financial advisor Scott Eichler of Standing Oak Advisors, who is also the author of the best-selling book “Don’t Play Chicken with Your Nest Egg,” offers the following example of how trying to save up 20% can backfire:

Imagine you and your neighbor want to buy an average home in Southern California for around $750,000, he says. Your neighbor decides to save $150,000 so she can put down 20% and avoid private mortgage insurance (PMI). Since she is a high earner, she can save 15% of her $250,000 salary for a home, or $37,500 each year. 

Unfortunately, that cash is languishing in the bank earning 0.1% in a savings account for the four years she’s saving. In the meantime, the house has appreciated by a modest 3% per year, which means your neighbor now needs $844,000 for a similar property.

In the meantime, you decide to go ahead and buy a home in that desired price range with just 5% down. While you paid PMI on the mortgage over the four years your neighbor was saving, you have considerable equity since your home appreciated 3% over that time and is now worth $844,000. Not only that, but you paid down your mortgage enough over four years to get a new appraisal and have the PMI dropped from your loan.

This example is pretty basic, but it just goes to show how trying to save up a large down payment can backfire, even in a market where housing prices are going up 3% per year. We all know that today’s markets are running wild, and that housing prices are going up much faster than that.

With that in mind, you may be wondering if the dream of saving up 20% is even worth it. This threshold will help you avoid paying private mortgage insurance when you take out a mortgage, but at what cost? 

We interviewed experts to find out what they think about saving up 20% for a home in today’s housing market, as well as whether it’s worth it. While all our experts agree your best next steps really depend on your unique situation, they had some tips anyone can apply.

Don’t be afraid to put down less than 20%

Patrick L. Ryan, who serves as CEO at First Bank, says it’s important to know that you don’t have to come up with a 20% down payment to get a mortgage. You may want to do so, but that’s a different story. The reality is, you may feasibly be able to get into a home with a down payment of 3.5% to 6% or 7%, says Ryan.

Depending on the lender, a conventional mortgage usually starts at 3% to 5% down, or up to $12,500 on a $250,000 home. 

While PMI is required with that kind of down payment, the lender will typically cancel this added expense on your mortgage once you have around 22% equity. In a housing market where prices are rising quickly, you may even be able to get an appraisal to prove you have 20% equity at some point, then have PMI dropped that way.

Lower your expectations

Financial advisor Josh Strange of Good Life Financial Advisors of NOVA says he believes consumers need to come to terms with the fact that homes are going to be more expensive over time, not less. Since the same goes for rent, there’s really no way to get around the level of housing inflation that is going on right now.  

With that in mind, he suggests being willing to make some changes in your financial life in order to be able to afford the home you want. For example, maybe you’ll have to cut your budget or drive an older car to make more room for the type of housing payment you will likely have.

“Also, purchasing a smaller or less expensive home may be a great move,” he says. “Getting to the ideal home is often a chess game and may take a few moves to get where you want to be.”

Consider loan alternatives

While you make your peace with putting down less than 20% on your home purchase, you can also consider traditional mortgage alternatives that can help you get into a home much sooner. 

Michele Hammond, a Chase Private Client home lending advisor, says that Federal Housing Administration (FHA) loans require only a 3.5% down payment, and they can be a good choice for cash-strapped borrowers. In addition to low down payment requirements, FHA home loans also come with low closing costs and more lenient credit requirements, so they can work for a broader range of consumers.

Eligible veterans and active-duty military can also look into VA home loans, which may not require any money down.

“Again, 20% down is not required for a home purchase,” says Hammond. She also notes that some of her clients who have the means don’t put 20% down due to other financial goals they have.

For example, some homebuyers choose to put down as little as possible so they don’t have to liquidate any of their investments, she says.

They will have to pay PMI in that case, but they may wind up ahead in other areas, such as avoiding immediate taxes on investment gains.

Only buy if you’re absolutely sure

Jeff Rose, who is the financial advisor behind Good Financial Cents, says today’s housing market is so hot that potential buyers should approach the homebuying process with a clear head.

“The last thing you want is buyer’s remorse after purchasing a home for 30% more than what it was worth just a year ago,” he says.

While you may want to buy regardless if you need a place to live and you plan on staying put, Rose says you should take stock of your entire situation before you buy at the top of the housing market — or at least the top right now.

“Unless you’re 100% certain that your job is intact and you are going to be living in this home for the next 10 years or more, that’s the only way it makes any sense to purchase,” he says. 

In some cases, it could even make more sense to keep renting than to buy at today’s prices, says Rose. This is especially true if you’re not really sure what you want your career to look like five or 10 years down the road.

Says Rose, “Having flexibility and not being tied down to a mortgage makes important decisions like a career change much easier.”

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