Don't put 20% down when you buy a home. For homebuyers who have significant cash reserves, the questions that arise when considering financing options are a serious matter. For example, should you put 5% down, 10% down, 20% down? What exactly is the best down payment to make when you have the ability to put some cash into your new home? The more money that you bring as a down payment, the lower your monthly mortgage payment.
On the other hand, it also means that you have more cash tied up in your home than the bank requires. So what do you do? Today we're going to look at three different scenarios that a cash strong buyer could consider.
And I promise you that you will take away a different perspective once you see the analysis I provide. Even if you don't change your mind, you will certainly have something to chew on before you decide what your down payment will be. Hi, I'm Joe Manassa, author of The Business of Getting Business and the creator of Manassa.com, where I've helped tens of thousands of people buy and sell homes.
I would like to help you too. If you already are a subscriber, thank you and welcome back. If you're not a subscriber, please consider becoming one now. We offer the most thorough and accurate housing market reports on YouTube, plus answers to your real estate frequently asked questions, and we also provide virtual tours of some of the most beautiful homes in Tallahassee.
Please remember to like this video, then hit subscribe and click the bell so that you're the most informed buyer or seller in your next real estate transaction. I want to preface my analysis with a note that I have attempted to produce a shorter video. Some of what I will reference as fact can be found in my recent videos on the Joe Manassa Real Estate YouTube channel, where I discuss at length many points that I just brush over in this video.
The purpose of this video is to act as a thought provoker. rather than specific guidance for when you buy your home. You should have a detailed conversation about how to finance your home with your trusted real estate and or financial advisor.
We are facing unprecedented times in the U.S. housing markets. Home values are skyrocketing as builders have not been producing enough homes to satisfy a growing population. With the cost of construction moving higher, faster and expected to accelerate, one can only imagine how home affordability is going to suffer. over the next decade or two.
Additionally, the 40 year trend of declining mortgage interest rates is about to turn around and perhaps head higher for the next 40 years or so. This generational change in interest rates and the soaring costs of construction will mean a very different housing market will emerge in the coming years. But it also provides an interesting opportunity for those who are paying attention.
I ask you to keep an open mind as I'm going to show you why you should not put 20% down when you buy your next home. As far as I'm concerned, there are really three ways you should go about determining your down payment. If you are wealthy and are debt adverse, just pay cash for your next home. If you are cash strapped, then look to one of the no money down loans you can get from USDA or VA or at least a low money down loan through the FHA or a conventional product. But if you are in the rest of us category and you happen to also be fortunate enough to have some cash reserves, Then I want to show you three realistic scenarios for you to consider.
Again, I might brush over some of my assumptions as I've not given them much attention, like how homes will appreciate over the next 20 years. But you will find my full analysis and discussion of these critical issues if you watch the videos on our channel. Two of the three scenarios that you are about to review will make a lot of sense to you, but the third might just blow you away when you first take it in.
Just remember, it's only a thought provoking exercise. Though I'm completely in the corner of this crazy option, we're at an interesting time in history. Mortgage interest rates are near an all-time low, but history tells us this will not last forever.
This graph plots 50 plus years of mortgage interest rates, and we can see that rates have been generally falling since the early 1980s. Today's rate is less than one half of the 50-year average, and I propose that these are borrowing times. There's a time to take on debt, and there's a time to avoid it.
Right now, They're lending money out at 3% interest. Can you invest that money for a return that exceeds 3%? I would argue that this is an easy yes. The real estate market is going to be moving away from home ownership and towards a landlord-tenant market when rates begin to rise.
Homes today are more affordable than they were in the 24 of the past 30 years, but we're about to see this trend turn upside down. Why? Because home values are exploding, and with the supply of homes for sale at historic lows, there is no immediate end in sight.
And if you're of the camp that believes that home prices are going to come down, you should watch my recent video and know that the average home price in the U.S. only declined in 10 of the years since the Great Depression of the 1930s. So investing in leveraged residential real estate right now makes sense because interest rates are at historic lows and home values are moving higher, supply is low, demand is high, and production on the supply side is nearly halted due to rising building and land costs. So here's my crazy thought for those buyers who have some extra cash.
What if instead of putting 20% down on your next home. Instead, you bought two homes. One would be for your personal residence and one would be used as rental property. You would lease it out to a tenant so you could enjoy the high rate of real estate inflation that we'll be seeing over the next 20 years. So what would the numbers look like?
Well, I produced this table that shows the investment required and the benefit received for each of the three different scenarios. Scenario 1, you buy a home where you put 20% down. Scenario 2, you buy a home where you put 5% down. And third, my crazy scenario, you buy two homes where you put 5% down on your residence and 25% down on the investment. Remember, this isn't for everybody.
You need more cash to do the investment than you need for the personal residence due to the loan product requirements. But if you have the cash, pay close attention to the crazy route. This graphic shows three side-by-side tables, each depicting one of the three scenarios mentioned prior.
Each table shows the equity you'll have and the return on your investment. The numbers appear incredibly high, but hang on and I'll explain it all. The first thing you should note is that all three examples show incredible returns. One might even say, unbelievable, right? Well, let me show you why they are, in fact, likely to occur.
First of all, the equity in each scenario is the combination of the down payment paid, the principal paid with each monthly payment, and the appreciation gained by owning a home during the highest appreciating market real estate has ever encountered. Remember, the combination of low mortgage interest rates and rapidly rising home values will put cash in your pocket. But even so, why is the ROI so high?
It's all about leverage. A portion of the purchase price is your investment. but it's the total value of the property that's appreciating. By way of example, if you buy $100,000 worth of stock and it goes up 16%, you've made $16,000, or a 16% return on investment.
But if you buy a $100,000 home and it goes up 16%, which is lower than this year's appreciation rate, you invest $8,000, which is $5,000 for your down payment, $3,000 in closing costs. Your $16,000 gain is not 16%. So, It's $16,000 minus the $3,000 in closing costs, all divided by your $8,000 investment, which is a whopping 163% return on investment.
Because of your use of leverage, you've gotten a 10 times better return than you would have through a stock purchase. I know the leverage example was overly simplistic, but it explains why leveraging residential real estate can be very lucrative during certain housing market cycles. This is one of those cycles, and it's stronger today than we've ever seen. So looking back at the table, all three options look great right now. The first table shows a 20% down payment and it brings a wonderful rate of return.
But it's ROI is the lowest of the three options. The table on the right shows a 5% down payment. It delivers the highest rate of return, but the gain in equity is the lowest. The table in the center is my crazy option, and it returns the most money of the three options. Why?
Because you're using your money to leverage more. real estate and that real estate is going to explode in value over the next 10 years it really is that simple okay maybe it really is not that simple when you buy stock you click a few buttons and then you go about your life you occasionally check on it to ensure nothing bad is happening but otherwise it's not an active investment that really requires you to do anything owning real estate is different if you hire a property manager you'll have less work that you need to do but it will still require far more of your time than would owning a stock investment. You'll need to ensure your manager is maintaining the property.
After all, that's your equity, and you'll want to review the property financials each month. I would argue that the ROI makes it worthwhile, but for some that wouldn't be the case. It's a personal decision you need to make.
I would strongly advise you to not jump into being a landlord. Rather, it would be prudent to first discuss the ins and outs. of property ownership with your trusted real estate advisor.
For viewers that are still bewildered by the returns shown in the table, I used the following information to create those tables. The appreciation rates of I used are 16% for years one and years two and then 5% annually thereafter. You can find my support for these in my recent home affordability video. The mortgage interest rates I used 3.1% for the owner occupied homes, and I added a full percent for the investment loan to 4.1%.
All loans were amortized over 30 years and required monthly payments. My equity formula is down payment plus appreciation plus principal paid. The ROI calculation is equity minus down payment minus closing costs, all divided by down payment plus closing costs. Made overpaid. The appreciation rates in the next few years will be mind-boggling, and that's why I prepared this video for our viewers.
If you would like to discuss your situation with us, we are here to help. Remember, with money being so cheap at 3% today, you should consider keeping your cash so that you can invest it at a rate higher than what you're paying to borrow money for your home. It just does not make sense to put 20% into your home today if you're still at a point in your life where you're trying to grow your wealth.
Even if you choose something other than leveraged residential real estate as your investment vehicle, certainly you can outperform the 3% cost of money. Right? If you would like to see more videos of my top tips for homebuyers, I've assembled a great playlist that you can view by clicking on the box on the top left corner of your screen.
For a playlist of answers to questions from viewers just like you, just click on the box below it. Please remember to like this video, check out the links below it, and subscribe to our channel so that you never miss anything.