Why You Need a Down Payment

My wife and I just got married and we'd like to buy a house soon. We've been setting aside money for the down payment but we have quite a way to go -- we'd need about $70,000 to make a 20% down payment in our area. We're wondering whether we should just go ahead and buy a house now with no money down or wait until we've saved the 20%?

Lenders are making it a lot easier to buy a house without the traditional 20% down payment. But you're going to pay a lot for that option. If you borrow more than 80% of the home's value, you'll usually have to pay private mortgage insurance, which protects the lender if you default on your loan. That tends to cost 0.5% to 1% of the loan value -- which could top $3,500 per year on a $350,000 home, or $5,000 on a $500,000 home. It's money that doesn't go toward your principal or interest and isn't tax-deductible.

Another option is to piggyback two loans. If you take out one loan for 80% of the cost and another for 20% (or for 15% and pay 5% in a down payment), you can avoid PMI and the interest on both loans is generally tax-deductible, but the rates on that second loan are quite high -- now running in the low- to mid-9% range.

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If you wait to amass the 20% down payment, you can avoid these extra costs, qualify for a lower-rate loan, and you'll keep your mortgage payments much lower -- which gives you a lot more flexibility in the future. "Some couples can afford the house when they're both working, but if a kid comes along and one wants to stop working, then they have a problem," says Michael Eisenberg, a CPA and personal financial specialist in West Los Angeles, Calif. Even in his area, where starter homes cost a lot more than $350,000, he recommends that young couples "sit back, stay renting, and save your money for your down payment." If your rent is reasonable and the housing market in your area has slowed, there's even less reason to rush into buying.

And in a slow housing market, it's particularly important to put down 20%, so you have some equity in case you do have to move earlier than expected. "In the early years, you aren't building any equity with the mortgage payment," says Eisenberg. "If the market changes or your personal circumstances change and you're forced to sell, you could lose money" if you made little or no down payment. The equity in your home can also give you an extra source of cash in an emergency.

And while you're saving, also work on improving your credit score, which can lower your interest rate. See Demystifying Your Credit Score for more information on improving your score.

For home-buying advice, see Tips for Buyers and Sellers and Home Buying Made Easy. And see our Real Estate Market Special Report for more information about the current state of the home-buying market