Most first-time homebuyers wonder if it is even realistic to get a mortgage without 20% down payment, they assume that they have to — or at least ought to — make a 20% down payment on their home to avoid paying private mortgage insurance (PMI). This can be a hefty sum in any city, but is especially burdensome in Seattle, where housing prices are well above the national average.

King County real estate has appreciated at an average of 6.71% during the past 59 years.

We will be conservative for our scenario, however, and assume appreciation to be 5%.* When the couple has finally saved the remaining $50,000 after 34 months, the $500,000 home will have appreciated by around $76,000.

Proponents of the 20% down payment will point out that the couple was able to avoid paying mortgage insurance, but how beneficial is this?

Their monthly mortgage insurance payment would have been around $79 if they had put only 10% down.

(based on a 30-year fixed mortgage, $450,000 loan amount, and 760 credit score).

Essentially, the couple missed out on $2,235 per month in equity so that they wouldn’t have to pay $79 per month in mortgage insurance.

Even if the couple from our scenario above had $100,000 saved when they first found the $500,000 home they wanted to purchase, making a 20% down payment may not have been the best idea.

This is because large down payments often lower a home’s rate of return.

Imagine that the couple purchased the home when it was still $500,000. After a year of appreciating at 5%, the home will be worth $525,000.

No matter how much the couple put down, they will have gained $25,000 in home equity. 

That’s a significant difference.

Of course, we have to take into account that making a lower down payment means paying a higher mortgage rate and private mortgage insurance. If we assume a 1.75% (or 175 basis point) bump from the higher rate and mortgage insurance, we find that the couple pays $8,487.50 more per year to live in their home when they make a 3% down payment. 

This may sound like a lot, but their return on investment is still over 100% — and still significantly larger than the ROI associated with making a 20% down payment.

As long as you live in an area where appreciation is expected,* as it is in Seattle, you can assume that the smaller your down payment, the larger your potential rate of return.

The risks associated with making a large down payment don’t stop with missed opportunities to gain home equity.

In fact, the larger the down payment, the larger the investment risk. 

Here are a couple additional risks to be aware of.

After making a down payment, you can’t easily get that money back.

The down payment you make on your home is immediately converted into home equity — a great asset to have, but an “illiquid asset,” meaning that you can’t access it easily.

(Your only option would be to refinance or sell your home, both of which cost money and take time.) 

Spending all of your savings on your down payment could easily leave you “cash poor” and vulnerable in the situation that an emergency requires quick access to cash.

An economic downturn could put homeowners who make large down payments at greater risk. 

When the U.S. economy declines, so do home prices.

Imagine that two buyers purchase a home worth the same price (one with a 20% down payment and one with a 3% down payment), but after a year those homes have depreciated significantly due to the economy.

While neither homeowner will have gained any home equity, the homeowner who made the larger down payment will have lost significantly more money to the housing market. 

Additionally, the homeowner who made a smaller down payment will likely be “underwater” at this point, meaning that they owe more on the home than the home is worth.

This obviously isn’t ideal, but it’s a risk that rests with the bank, not the homeowner.

The bank will be less likely to foreclose on this underwater home because doing so could cause it (the bank) great losses. After all, all the money lost is money that the bank itself lent. 

Every homebuyer’s financial situation is different, meaning that there isn’t a “right” down payment size for everyone.

But before making a decision, every buyer should consider both the potential costs of waiting to buy in an appreciating market and the potential risks of making a large down payment.

Working with a certified mortgage planner, such as Seattle Mortgage Planners, is the best way to make an informed decision that maximizes your future financial security. A trusted mortgage planner can help you review your options and determine the best plan, both in terms of how large of a down payment to make and what mortgage type to go with.

And once you know how much money you have to work with, The Madrona Group will be ready to help you find your dream home.

*Appreciation can fluctuate from year to year and is not guaranteed. For our scenarios, we assume that it will be conservatively positive because of Seattle’s historical positive averages.