Many years ago, my husband and I bought our first home with only a 10% down payment. The decision to do that ended up working out OK. But in hindsight, I didn’t realize the risk I was taking on.
Now that I’m older (and hopefully a little wiser), it’s a mistake I wouldn’t make again.
In fact, I will never buy a home with less than 20% down again. And there’s one big reason why.
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There’s a big risk to buying a home with a small down payment
There are a lot of downsides to buying a home with a low down payment. But for me, the biggest reason I believe it’s a bad idea boils down to one thing: You could easily end up underwater on your home, which means owing more than it’s worth.
After having bought and sold several homes in my lifetime, I’ve learned that there are huge transaction costs associated with a home sale. If you hire a real estate agent, you’ll have to pay around a 6% commission to sell your home. And even if you don’t, you’ll almost assuredly end up paying 3% to a buyer’s agent because the person who purchases your home will probably be represented by a real estate professional.
There are also closing costs to pay, which can add up to thousands of dollars. And if your home needs repairs in order to attract a buyer, these can be expensive too.
Because of all these costs, you could very easily end up unable to sell your home for enough to pay off your mortgage lender and cover all of the additional expenses associated with the sale. And that means you could end up trapped in your home unless you have extra money so you can pay off your loan balance and cover everything else.
Unfortunately, if you’ve made a small down payment, you’d need property values to go up quite a lot. Or you’d need to be in your home a long time and pay down a good portion of your loan balance — in order to not find yourself in a situation where it’s difficult to sell your home for enough to cover everything.
If you put 20% down, on the other hand, you have a big cushion to absorb sales costs. This can help if you have to sell before you’ve had time to pay much on your loan or see your home go up in value enough to cover your costs. You’d also be better positioned if your home ends up going down in value.
Of course, the risk of not being able to sell for enough money is just one of several reasons why putting a small down payment on your home might be a problem. You’ll also owe private mortgage insurance if you put down less than 20%. That’s a type of insurance that protects the lender in case of foreclosure so they don’t lose money when your down payment is a small one — but you have to pay for it even though it doesn’t protect you.
To me, the risk of a small down payment causing you to owe more than your home is worth is the biggest issue. That’s because I don’t want to be trapped in a situation where I can’t sell unless I come up with thousands of dollars in extra cash. And that risk is something worth considering before taking out a home loan without putting much money down.
But if a low down payment is what works best for you, the good news is you have plenty of options, including:
For more information on the pros and cons of a small down payment, be sure to check out our guide to learn how to buy a house with zero down payment.
View more information: https://www.fool.com/the-ascent/mortgages/articles/the-1-big-reason-id-never-buy-a-house-without-a-20-down-payment/