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When you buy a house, you typically need to put some amount of money down. Lenders require you to do this in order to reduce the risk that the house will end up not being worth enough to guarantee the mortgage in full.
It's also a good idea to put money down so you don't end up owing more than the house is worth (this is called being underwater). This could make it very difficult to sell if you needed to because you would have to come up with the remaining cash to pay down the loan.
Although lenders require some down payment, you typically can choose whether to make a small payment or a large one. This can be a difficult decision because the bigger your down payment, the less your mortgage costs -- but the more money you have to save up before you can buy.
To help you make your choice, finance expert Dave Ramsey has some advice -- and it's actually pretty surprising from the well-known anti-debt guru.
Here's why Ramsey's advice is so surprising
Ramsey's minimum recommended down payment is much lower than you would expect it to be, given that he recommends avoiding debt whenever possible and ideally suggests buying a house with cash if you can afford it.
So, what does Ramsey suggest is the minimum you need to put down? "If you’re a first-time home buyer, a 5–10% down payment is fine," the Ramsey Solutions blog says.
The fact that Ramsey says it is OK to buy a home with so little down is really surprising for a few reasons.
First and foremost, as Ramsey acknowledges, if you put down less than 20%, you are going to get stuck with an added payment for something called private mortgage insurance (PMI). "Anything less than 20% is considered riskier for a lender—so to cover their butts, they make the mortgage more expensive for you by adding things like private mortgage insurance," Ramsey said.
PMI protects the lender by covering any costs they can't make up if they have to sell your house in a foreclosure. But it doesn't protect you -- you can still be foreclosed on even though you're the one paying for the protection. So, by suggesting that it's OK to buy a home with just 5% down, Ramsey is OK moving forward with a purchase that's going to come with higher monthly payments that will affect your ability to do other things with your money.
Ramsey also said that, "Anything less than 5–10% is actually a very weak down payment, not to mention a sure-fire way to wind up upside down on a home. And you’ll waste a lot of money in interest and fees over the life of your mortgage." But this is also true if you make a down payment below 20%. You will likely get stuck with a higher interest rate loan, you'll have less choice of lenders, and you'll have to pay added fees if you choose special low down payment loans such as an FHA loan.
Now, to be fair, Ramsey does indicate that people who are already homeowners should definitely put down 20% because they can cash in their equity to come up with the down payment. And he does make clear that a larger down payment is better even for first-time buyers.
But while he says a 5% to 10% down payment is fine for those who are purchasing a home for the first time, the reality is that this is going to be a risky and costly move -- especially if you're at the lower end of that range.
How big should your down payment be?
In most cases, even if you are a first-time buyer, you should try for a 20% down payment to protect yourself and avoid making your mortgage costlier. But, if that's completely impossible for you, you should stick with a minimum of 10% -- not opt for just a 5% down payment.
Anything less than 10% is going to put you at serious risk of being unable to sell your home for enough to pay off the mortgage, as well as to cover closing costs and real estate commission. You just don't want to take that chance.
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