personal finance

Downpayments: Why 20% is the Magic Number for Home Purchases

 
Richard Davey  CPA, CFP®

Richard Davey

CPA, CFP®

Trevor Scotto  CPA, CFP®, CDFA  ®

Trevor Scotto

CPA, CFP®, CDFA

®

 

Remember learning about how much money you should put down when buying your home in high school?  Me neither. Wouldn’t it be nice if someone would just tell us what the right amount is? Here are a few reasons that we recommend having at least 20% as a down payment.

1. You will avoid unnecessary fees

Private Mortgage Insurance (PMI) is insurance that is solely intended to protect the lender in the case you can’t keep up with your mortgage payments, but you are the one required to pay for it. PMI is usually thrown into the total costs of the mortgage when you, as a lendee, put in less than 20% of the down payment.  

This is important for you to know about because PMI could be costing you hundreds of extra dollars each month to buy your home without any tax advantages (or benefit to you). Many Americans pay PMI each month, but that doesn’t mean you have to.

On average, PMI costs around .5% to 1% of the loan amount. This means that for a $400,000 mortgage, you could end up paying up to $400 extra a month, just to protect the mortgage lender. We would prefer this cash go to your retirement/emergency fund or even your leisure fund.

Note that these extra PMI payments typically terminate when the equity in your home reaches 20%, but not always. In some cases you can get your PMI waived, but we would still recommend being cautious about moving forward with that kind of arrangement, as we’ll expand on in point #3.

2. Potentially qualify for a lower interest rate

If you put 20% down, you have a lot to lose in a bank foreclosure if you miss your payments. Because you have put a good chunk of the value down as a payment, the lender will likely offer you a better rate knowing you have a lower risk of missing payments and walking away from the house entirely (foreclosure) vs. someone who is only putting down 5-10%.

Even a small reduction in your interest rate can go a long away. For instance, a $500k 30 year loan with a 4.75% interest rate incurs ~$23,500 in interest expense in the first year of the loan. That same loan with a 4.25% interest rate incurs ~$2,500 LESS interest. That’s $2,500 staying in your pocket vs. going to the bank.

3. Reduce your chances of buying “too much home”

Every dollar you borrow increases your mortgage payment which increases the chance of being overextended in your home budget. Lenders prefer the 20% down payment because it shows the buyer is serious about the home and their intention to stay in it while making timely payments. After all, if you buy a $500,000 home with a $100,000 down payment, you are going to fight tooth and nail to make timely payments to avoid putting your $100k down payment at risk. If you only put 3% down ($15,000) there is less incentive to keep up when times get tough.  

It’s usually a good rule of thumb to avoid acting in a manner that would characterize you as a “high default risk” buyer in the eyes of the bank. If the bank would classify you as “high default risk” for putting down less than 20%, you should probably take that personally. Do YOU want to put yourself in a position of high default risk? After all, foreclosures are horribly damaging to your credit score and ability to borrow in the future.

The bottom line is this, the next time you are looking at your next home, make sure you have enough to afford at least a 20% down payment. 

 

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Financial Advisors: What to look for when shopping for one

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Richard Davey

CPA, CFP

So, you’ve set out to get “serious” about your finances. Maybe it was your new year’s resolution to make some progress on your financial picture, you’ve had (another) quazi-argument with your significant other that’s rooted in a financial disagreement, or you’ve just found out about a colleague who is throwing a housewarming party and maybe you've got just a hint of envy. Whatever the trigger is, your intention is to take the next step with your finances.

But, where do you start? Maybe you’ve been putting a portion of your income into a savings account but it’s basically earned you nothing extra. You know that you should be letting your “money work for you”, but, what does that mean exactly? What type of investments should you consider? Ok, so there’s mutual funds, stocks, bonds, and ETFs. What is an ETF? You’ve read something about permanent life insurance being the best option while you also read a headline that says that’s the last thing you should do. Is it worth investing your time in doing it yourself with Schwab, eTrade, Fidelity, TD Ameritrade, etc. or do you work with an advisor?

It’s clear that all of this has gotten overwhelmingly complicated. This complexity is the exact reason so many people, even when they have the desire and financial ability to participate, tend to put it off. The number of investment options alone makes thinking about getting involved with investments uncomfortable enough to kick the can down the road for years at a time. But, in the back of your mind, you know you can’t just pretend it doesn’t exist forever.

Financial complexity tends to cause people to put off decision making.

Financial complexity tends to cause people to put off decision making.

After almost eight years of studying in school, a handful of professional designations, and working with over a 100 clients, I’ll never know everything about finance, nor will I ever. As with most professionals, I’m a proponent to sticking to what I do best, and I rely on others who do the same at their own different disciplines. Therefore, this blog will be about the types of advisors couples should consider hiring - not the options for doing it yourself.

At its core, financial planners are responsible for advising clients on the best way to save, invest, grow, and protect their money. Maybe you have a specific financial goal - such as readying yourself to buy a house or fully funding your children’s education - or, they can help give you a high level view of your various assets. Some specialize in retirement or estate planning, while some others consult on a range of financial matters.

For those in relationships, couples should start with understanding and getting aligned with each other. Couples need to understand each other’s feelings on risk tolerance, spending priorities, and agree on some joint goals. If you'd like a cheat sheet to help you get started with establishing joint goals, add your e-mail below to get access to the link. 

Once you’ve started establishing where you stand as a couple, I recommend taking some time to shop for a financial adviser:

  • There’s a couple of different ways advisors can get paid, and it’s import to understand how the difference in incentives impacts the way they do their job. Take some time to research and interview each framework. This is not an exhaustive list but should give you a good place to start.

    1. Hourly Planner

    2. Commissioned Broker

    3. Fee-only Advisor

  • Get referrals from people in your network, including co-workers. Employee benefits plays a pivotal role in your finances. Advisors who are already familiar with how benefits work for your organization will have an advantage.

  • Research the firms backing the advisors you choose to interview. No I don’t just mean Yelp. In fact, a lot of advisors won’t even be on Yelp for compliance reasons. Look at Glassdoor.com. This site has a library of employee reviews on the major firms. Posts from disgruntled employees is a BAD sign and may indicate the firm’s values are questionable. It may also lead to high advisor turnover putting your accounts at risk of being “orphaned” if your advisor gets fed up and leaves the firm or industry altogether. General google searches might turn up some interesting pieces of evidence also.

  • Question the experience of the advisor. What makes them competent to handle your finances? If they are new to the business don’t just write them off. They may have a mentor working with them on their accounts who has stellar insight from decades of experience. If you end up gravitating to someone younger, I would simply ask to have their more experienced supervisor collaborate with the younger associate in handling your case. In doing so, you might just get the best possible service from the newbie who has something to prove in keeping you happy whereas the 60-year-old VET nearing retirement probably doesn’t need your business quite so much.

  • Ask for their credentials. Do they hold professional designations? If so… which ones?  It’s a joke how easy it is to get certain initials behind your name in financial services these days. The big three, per several very well-respected publications, are the CFA (Chartered Financial Analyst), CFP® (Certified Financial Planner), and CPA (Certified Public Accountant).  These credentials require substantial real-world experience to obtain the marks along with several months if not years of study to pass the exams.

  • Do a background check. Almost all financial advisors can be investigated as most regulators require us to publish information about past disciplinary history, major client judgments/complaints, bankruptcies, criminal convictions, etc. Below is a list of links where you should be able to look up your advisor’s record and status of their license. If they are not willing to help you do this, be weary.

Do your research and enable yourself to make confident decisions moving forward!

Sincerely,

Richard Davey