Zero Down Payment On A House Is Just Fine

by Mike Holman

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Now that we are in the sub-prime era, it has become very fashionable to declare that home owners that bought houses with little or no down payment are a big reason why foreclosures are at record levels. I have to respectfully disagree.

In my opinion, when buying a house, it doesn’t make a big difference how much of a down payment you have. Ideally, if you have 20% or more then you save on fees and interest which is a good thing, but if you are set on buying a house and you have don’t have anywhere near 20% then I wouldn’t worry about it.

The down payment has nothing to do with the affordability of the house

Your ability to make your mortgage payments will determine how well you can afford your house which is completely unrelated to the size of the down payment. In other words, it’s the size of the mortgage that matters. Now you might be thinking that for the same house price, a larger down payment will reduce the mortgage which will reduce the payments. This is true, but unfortunately most house buyers don’t think that way. Typically they will look at how large a mortgage payment they can afford, figure out a maximum mortgage and then add their down payment to the maximum mortgage to give them their maximum house price. This of course will get thrown out the window once they start looking at houses but that is at least, how the initial house price maximum gets calculated.

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An example

One house owner, let’s call him “Mike” bought a house for $168,000 with $20,000 down payment. Because he only had 11% down payment he had to pay an extra insurance fee of $3700 which left him with a mortgage of $151,700. With a 30 year amortization mortgage at 6%, his monthly payment is $902.

Another house owner, let’s call her “Sue” bought a house for $268,000 with $53,600 (20%) down payment which left her with a mortgage of $214,400. She avoided any extra fees because she had the 20% down payment and she also qualified for a better mortgage rate of 5.6%. Her monthly payment is $1222, 35% higher than Mike’s payments!

In this case, Mike’s house was more affordable even though he didn’t have as big a down payment as Sue.

Down payment is only one factor

Having a larger down payment is preferable to a smaller down payment, but not having an arbitrary percentage shouldn’t stop you from buying a house. It’s important to look at all the numbers which affect your ability to afford the house – mortgage payments, taxes, utilities, maintenance etc and decide if it make sense to buy a house with a small down payment or wait until you have a larger one.

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{ 13 comments… read them below or add one }

1 Emily

“Now you might be thinking that for the same house price, a larger down payment will reduce the mortgage which will reduce the payments. This is true, but unfortunately most house buyers donít think that way.”

I do think that way and all my brain goes to is that Sue could’ve put her $53,600 onto the $168K house instead of the $268K. I’ll never understand the need to stretch to live in the most house one can possible tweak the numbers to make it look like they can afford.

Although mortgages make me itchy and I don’t have one myself, I do think there is a time and place for little or no down payment.

2 paidtwice

We had no down payment! lol

Actually, I wish we had, but such is what it is. We bought much less than what the bank approved us for, but we were looking at a payment number we didn’t want to go over. if we’d had a down payment, I have to admit we’d probably bought more house but still stayed under our max “payment” we were comfortable with budget wise.

And then maybe today i wouldn’t be replacing our furnace. :)

3 Enough Wealth

The main benefit of buying a house with a down-payment (aka. a ‘deposit” in Australia) is that if you were able to save up the deposit then you should be able to make the payments. If you haven’t gone through the discipline of saving up a deposit there is a greater chance of not making the mortgage payments and falling behind.

4 Pete @ biblemoneymatters

One reason we made a big down payment was because we didn’t want to have to pay the large private mortgage insurance payments that most companies will tack on if you have less than 20% equity. I’m glad we did because that would have been quite a bit extra tacked onto our payments every month. Also, since our property taxes went up almost $2000 after our first year in the house, that little bit of extra money that we weren’t paying for PMI was very helpful.

5 Investizmo

I have to respectfully disagree.

The reason a downpayment is important is that it builds an initial equity in the property. In the first few years of a zero down mortgage, you’re paying essentially 100% interest, no principle.

So what happens when you cannot afford the house? Bail! There’s no reason to pay the bank money on interest when you have nothing to lose no equity equals no loss on foreclosure.

6 Nurseb911

You make a valid point in example as it points out the facts of affordibility, but I want to “own” 20% of my home vs. the banking owning 95% (or more). The problem down in the US was that with minimal home equity, the drop in prices across the market virtually wiped people out and now the bank owns them too.

Oh course…..you’re reading a comment from the guy who has about 40% to put down on his future home, so I’m in the camp that’s a strong believer that becoming “debt free” is more important than the affordability of a monthly mortgage payment. It will entirely depend on your personal situation, rent, etc. But owning some vs. none of your home is a much better option IMO.

7 Kyle

I only put 5% down on my condo, but it was a condo I could afford. The problem comes when people put 0% down on a house they couldn’t afford even if they put 20% down. The 20% rule makes sense for banks to give them a margin of safety, but it’s not particularly relevant to prudent homebuyers.

8 Mr. Cheap

Enough Wealth: I tend to agree with you, although Mike’s post makes perfect sense to me. Say someone had been spending everything they make, then reached a turning point in their life where they started living below their means and saving aggressively. Maybe buying property they can easily afford the monthly payments on makes sense, even if they haven’t accumulated 20% down yet.

I’m a “avoid PMI at all cost” kinda guy, but I understand and appreciate that there are situations where it makes sense to buy with a lower down payment.

9 Nobleea

I have to agree with FP. Though, if you’re strictly focused on the monthly payment and picking one you can afford, who’s to say some won’t start looking at longer ammortizations?

I don’t think having no equity in a home makes you more likely to bail. Pretty much everyone who’s bought a car new has no equity in it, but you don’t see anyone foreclosing on them. Because you need a car (well, that’s debateable), and because you can afford the payment.

People are essentially chasing returns when they get rid of a house because they have no equity in it. They’ve come to believe that houses are investments, and now they’re showing a paper loss, so better move to something better. If you stop thinking of houses as investments (and more like savings plans), then you’ll care less about how much your house value has gone down (and conversely, how much it’s gone up).

10 Al

I agree with FP that down payments don’t mean anything if you buy a more expensive house because you have it. But this isn’t the way people should be buying houses.

If someone has fixed payments and purchase price in mind when they go house hunting, then the a downpayment reduces the amortization period. That’s where the value lies. Shorter amortization mean more going to principal and less to interest.

I don’t like the mortgage calculators that don’t show the total interest paid. People should understand the full cost of a mortgage and how much extending the amortization hurts.

11 Derek

One thing to consider is that if you are currently renting and thinking of buying a house, is that if you can get the place and pay the same amount per month as you do in rent it would be better to buy even if you get an interest only mortgage. Since over time your rent will go up but your mortgage payment will not.

12 Siddharth

The context of the blob was to relate the downpayment to the subprime problem that the financial markets are in now.

I do think that poor lending practicises like allowing people to own home with 0 or very less equity is one of the problem in the first place.

By having such lending practises the home owner basically made the mistake of over paying for a home. Which is the reason why the home prices in US were zooming in the 4 years prior to late 2005 or early 2006.

Now when the home prices started to slide down the home owner with little down payment or the Investor with little down payment and looking for capital gains from trading the property decided to cut the losses. When there are more sellers it becomes a buyers market and the prices fall further causing such people to move more into debt and eventually foreclosures.

Hence the amount of downpayment (larger) will have had a lesser imapct on the housing and the mortgage markets

13 Four Pillars

Lots of comments! For the record I do think having a big down payment is better – a 100% down payment is the best!

Emily – but you are a smarty pants!

PT – sounds like you bought something you could afford – which is a good thing!

Enough Wealth – I don’t disagree with that point.

Pete – the insurance is a great reason for a down payment. When I bought my first house I didn’t have 25% so I had to pay $3700 in extra insurance which still rankles me to this day.

Investizmo – the amount of interest paid on the initial payment is determined by the amortization (ie 25 years) rather than the size of the down payment. Also – walking away from the house is only an option in the U.S. and even there I understand it’s only certain states that allow you to walk without recourse.

Nurse – if you have a 40% down payment then clearly you aren’t buying enough house. :) Seriously, congrats on the big DP.

Kyle – I agree.

Cheap – see previous comments – I completely agree.

Nobleea – interesting thought about chasing returns – I never thought of it that way before.

Al – too bad most house buyers don’t think like that.

Derek – I don’t agree with you because you are ignoring all the extra costs with owning a house ie taxes, maintenance. What if you rented and invested the difference? Which method will work out better?

Siddharth – no down payment is indeed a lending practice that should be only be allowed under certain circumstances. Unfortunately, everyone and their brother took advantage of it.

Mike

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