When planning to buy a property with financing one of the biggest decisions is your down payment. How much should it be?
Many times this will be dictated by the loan terms. However, the loan type you are using is likely dictated by the amount you plan to put down, among other factors.
Typical Down Payment Amounts
The most common down payment amounts we see in real estate is 20 percent and 3.5 percent.
20 Percent Down Payment
There are several reasons people put 20 percent down:
For one, it avoids Purchase Mortgage Insurance (PMI). If you are not already aware of this, basically when you purchase using a loan and will have less than 20 percent equity in the property, you are stuck with this additional cost every month.
It’s one of a couple reasons I prefer to put 20 percent down on my properties when purchasing.
Also, 20 percent down gives you an instant buffer. Yes, you are putting the money up to create that equity, but you are also not stuck either if you need to sell.
Let’s say you need to liquidate the property before you planned, for whatever reason, doesn’t matter. Life just happens sometimes.
If you have 20 percent equity in the property than there is a high likelihood you can sell it without coming out of pocket. Let’s say, unfortunately it’s during a down turn in the housing market and your property is worth the same as the purchase price or even less. Without that equity, you will likely need to come out of pocket just to sell it!
Taking a Loss Either Way?
Yes, I know what you are thinking. Won’t I be taking a loss on my down payment though? If you ever stumble into this unfortunate scenario, yes you would. However it is money you already laid out when you purchased the property. When you had the ability to do so.
If someone is selling at a loss it is likely not because they want too. It’s because they have too, and in that scenario there is a good chance they won’t have any money to lay out when selling it.
Like I said, it is a buffer. Call it a safety blanket. It is my preferred method though as I never want to be “stuck.”
3.5 Percent Down
You see this more often with first time home buyers and investors who buy it as their primary and then eventually turn it into a rental when they upgrade homes.
There are pros to this as well. The obvious one being that you need to come up with a lot less money to get into a home.
This down payment amount is most commonly seen with FHA loans, which has advantages such as a lower credit score requirement.
In the end, you can put down whatever you lender is able and willing to work with. I have seen 1% down loans coming back of late (probably not a good thing) and have seen people do 5% and 10%.
The positive side of putting less down is further leverage on your money. If you put 5% down on a property rather than 20%, then you have that other 15% to acquire more properties.
Just be sure not to over leverage yourself. That is how everyone got caught with their paints around their ankles in the last down turn.
The most important takeaway is that you can work with your lender or shop lenders to find the terms that best work for you.
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