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I bought my house with only 3 percent down. Should you?

A house.
A house.

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One of the most pervasive myths about buying a home is that you need to have tens of thousands of dollars socked away in order to do it. It's true that you need a down payment, and that 20 percent down payments are very common. But they're not the only game in town.

Case in point: When I bought my condo, I only put 3 percent down. It amounted to about seven months' worth of mortgage payments — a non-trivial amount of savings, but way less daunting than the tens of thousands of dollars a 20 percent down payment would've required.

A big disadvantage of a low-down-payment mortgage is that you will likely have to pay higher interest rates and other monthly fees. However, for many people, the advantages of being able to buy a house earlier will be worth it.

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Why is this an image
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Con #1: You'll probably have to pay more than with a big down payment

A big down payment leaves you with a smaller loan, which means you'll pay less overall in interest, making the house functionally cheaper over the long run. That means there's a financial incentive to put forward more money in the beginning.

Moreover, many lenders require that borrowers putting less than 20 percent down purchase mortgage insurance, which compensates the lender in the case of a mortgage default. Loans backed by the Federal Housing Administration, which might otherwise have more favorable terms, also require mortgage insurance payments, and pretty big ones at that. This is money that's typically added to your monthly mortgage payment that you'll never get back, and you want to avoid paying it.

There are other models as well. Some mortgages include a large initial mortgage insurance payment, meant to cover insurance costs until the borrower has paid back 20 percent of the loan, at which point insurance is no longer needed.

Con #2: The interest rate might be higher, but it varies a lot on the lender

Sometimes lenders will mark up interest rates for mortgages with less than 20 percent down, which could make low down payments cost even more relative to big ones than they already do. Higher interest rates are also sometimes used as an alternative to borrower-paid mortgage insurance, which in some cases could cost the borrower more than if they paid for insurance instead.

Be sure to shop around; interest rates are currently hovering a little below 4 percent, and if you're in an urban area with lots of lenders, you should try to find a lender who'll offer a rate at or below the median, even with less money down.

A house, in water
Real underwater mortgages don't look nearly this whimsical.
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Con #3: Low down payments make it easier to buy houses you can't actually afford

A final danger of a low-down-payment mortgage is that you could get stuck in a house you can't afford. Homeownership is financially risky; there's no landlord to bail you out if a major appliance breaks down, and it's not easy to cut your housing costs if your income falls. So when you buy a house, it's a good idea to be conservative, and make sure you can comfortably afford the monthly payment.

If you're not sure about this, saving a conventional 20 percent down payment can serve as a reality check. If there's enough room in your budget to save a 20 percent down payment over a few years, there's more likely to be enough room in your budget to cover unexpected home-repair expenses or a spell of unemployment.

On the other hand, if you find yourself struggling to save enough money for a 20 percent down payment, that might be a sign that you need to consider less expensive housing options.

money
Don't pay your down payment in literal $100 bills. Or maybe do, I don't care.
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Pro #1: Spending more money later might be worth saving less now

While a low down payment will probably wind up costing more money than a big one, due to both more interest payments and mortgage insurance, that's not necessarily a deal breaker. There's value in having money now rather than in the future (economists call this the "time value of money"), so it's not irrational to accept bigger payments in the future to avoid a big payment in the present.

People also usually get raises as they progress in their careers, so paying a big down payment early might wind up costing you more, as a chunk of your income at the time, than making slightly bigger monthly payments (which get cheaper every year due to inflation) over the course of the loan.

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Sometimes you gotta take it to the stock market.
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Pro #2: You might be able to invest the extra money more productively

When you make a large down payment on your house, you're effectively using your house as a savings vehicle. The larger your home equity, the smaller the interest you have to pay on the outstanding loan.

But the interest rate on mortgages is really low right now — around 4 percent. And if you're young, you might be able to get a better long-term return by doing a smaller down payment and putting the extra money into an index fund. Stocks have traditionally earned around 6 percent per year — after inflation — so your investments might earn more in returns than the costs of higher interest payments.

There are two big caveats, however. One, this only makes sense if you can find a low-down-payment mortgage with terms that are as good (or nearly as good) as a traditional 20-percent-down mortgage. If you get a low-down-payment loan with a higher interest rate, the higher interest rate will apply to the entire amount you borrow — so even if you're able to get a higher rate of return on the 10 to 17 percent you don't put toward the mortgage, that may not offset the higher interest you're paying on the remaining 80 percent you owe to the bank.

Second, building home equity is a safer investment strategy than buying stocks. While the average return on stocks is about 6 percent, the rate of return varies a lot over time. And there's no guarantee that stocks will perform as well in the future as they have in the past. If you're unlucky, you could wind up paying more in extra interest than you earn from your investments.

A house. On a street. With a garden.
A pretty great house.
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Pro #3: Owning a house can be great

Often, your choice isn't between a low down payment purchase and a high down payment purchase. It's between buying a house with a small down payment now and continuing to rent for years because you can't afford a larger one. And even if you're only putting 3 to 5 percent down, the former can have major benefits.

If you buy a house with a fixed mortgage, you're protected against rent spikes in your neighborhood. If the value of your home spikes, you're worth more; if the value of the home you're renting spikes, you'll probably have to start paying more. You also get a degree of customizability. If you really want, say, a big built-in bookcase, odds are you're going to need to buy a condo before installing one.

Finally, the US tax system privileges home ownership by offering a mortgage interest deduction. This doesn't matter for most people, as its benefit doesn't outstrip that of the standard deduction for middle-income households. But if you make high five figures or above, it can make owning a very attractive proposition.

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