Saving up for your first home purchase is never easy, especially if you plan to follow the “20 percent rule.” In fact, many homebuyers plan their housing budgets on the amount they’ve already set aside to purchase their first home in Chicago.
A couple with $120,000 or more in liquid savings might set their purchase price limit at $500,000 – with $100,000 to put toward their Chicago condo down payment and $20,000 for other incidentals, including closing costs, moving fees and an emergency cushion.
So what happens if you don’t have a massive lump sum of cash at your disposal? Are you still priced out of homeownership? Not quite.
The 20 percent rule
Despite what you’ve heard, putting 20 percent down on a Chicago home purchase is an ideal scenario, not a requirement for a mortgage. The minimum down payment needed for a conventional loan is just 3 percent. For an FHA (Federal Housing Authority) loan, borrowers need a minimum of 3.5 percent of the purchase price upfront. If you qualify for down payment assistance, you might not need very much at all to get started. PERL Mortgage has a program running right now that provides buyers (not limited to first-time) up to $10,000 in down payment assistance as long as they fit the following criteria:
- Primary residence only
- 640 credit score minimum
- $1,000 minimum contribution
That being said, there are financial advantages to putting 20 percent down upfront which, for the most part, have to do with having more equity in your home and being less of a lending risk.
The cost of borrowing more
The biggest difference you’ll notice when putting 20 percent down as opposed to 10 percent, for instance, is the cost of your monthly mortgage. The best way to demonstrate the differences in mortgage payments based on down payments is to calculate a conceivable Chicago homebuying scenario.
Buyer no. 1: Assume buyer no. 1 is looking to buy in ultra-popular Lincoln Park, where the current median home price is $470,000. The current average 30-year fixed mortgage rate is hovering around 4.27 percent. Following the 20 percent rule, a mid-range homebuyer in Lincoln Park would need $94,000 for an “ideal” down payment. Consequently, their monthly mortgage totals $2,320.18 – principal, interest and property taxes included.
Buyer no. 2: Now assume buyer no. 2 is looking at similar homes and decides to put down 10 percent upfront instead. For brevity, we’ll also assume buyer no. 2 is preapproved for the same interest rate of 4.27 percent. Buyer no. 2 is looking at a down payment of $47,000 – a much smaller burden on their bank account. However, buyer no. 2 faces a higher monthly mortgage payment of $2,784.59. That’s because with less than 20 percent down, buyer no. 2 is required to pay Private Mortgage Insurance (PMI), adding about $232.65 to the monthly mortgage.
With 10 percent down, interest would comprise a larger chunk of buyer no. 2’s mortgage, decelerating his or her equity-building timeline. For the first month of homeownership, buyer no. 1 pays 1,337.93 toward interest and $516.17 toward principal (i.e. equity). Meanwhile, buyer no. 2 spends $1,505.18 on interest and $580.69 on principal.
The fiscal benefits of putting more money down upfront are strong, which is why so many house hunters stick to the 20 percent rule. You own more of your home sooner (a larger down payment equals more immediate equity) and your monthly payment is lower because you’re financing less of the home purchase. And, you avoid PMI, which will only disappear after the 20 percent equity threshold is reached. That $250 or so paid for PMI each month could alternatively go toward a retirement plan such as an employer-sponsored 401(k), an IRA or another investment account.
**These numbers do not include Homeowner’s Association (HOA) dues. When deciding how much home you can afford, don’t forget to factor HOA costs into your (hypothetical) total monthly housing bill. After you’ve gone under contract, your lender will consider those costs during the mortgage approval process.
When to reject the 20 percent rule
The big question is: should you delay your 2018 homeownership dreams, save up the additional $47,000 and abide by the 20 percent rule? Not necessarily. If you postpone your home purchase another year or two, you might face a higher interest rate. In fact, the Fed is promising to raise rates in 2018, so this is a likely scenario. Plus, with Chicago home prices ascending, the home you want now could cost more down the road. If you buy now and home values continue to rise, you earn those increases that can be cashed out at resale.
Often times, the main reason homebuyers choose to put 10 percent down now instead of waiting until they have 20 percent saved is because they are tired of paying rent. The average rent for a 2-bedroom in Lincoln Park is $2,255 (RentCafé), all of which could be considered money left on the table. With 10 percent down, the mid-range Lincoln Park condo for sale could cost more than your rent, but you’ll regain a portion of each monthly payment to help build long-term wealth. In several Chicago neighborhoods, buying is cheaper than renting and first-time buyers see the savings almost immediately.
Not everyone is cut out to buy a condo in Chicago, even with a 20 percent down payment and closing costs saved. Consulting with a Chicago real estate agent to discuss your homeownership options and receive valuable, professional feedback is a must. With the spring homebuying season quickly approaching, now is the time to get serious and weigh your options. To get tailored advice and speak to a local real estate expert, contact Z Chicago today.
