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Use the 20% Rule to Guide Real Estate Decisions

April 21, 2016
Home Affordability, Mortgages
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By Mazen Fawaz

Learn more about Mazen on NerdWallet’s Ask an Advisor

When you’re buying a home, it can be tough to keep all those rates, percentages and scores straight — especially since they’re constantly changing.

But there’s one number that should stay fixed in your mind: 20%.

Keeping the 20% rule in mind when considering a home purchase will keep you on the right side of financial freedom, flexibility and security. Here’s how it works.

Borrow 20% less

You feel ready for homeownership. You ran the numbers in affordability calculators. You got preapproved for a mortgage.

Now remember this very important mortgage rule: Whatever the bank says you can afford, borrow 20% less.

That’s right: If the bank approves you for a $500,000 mortgage, borrow $400,000. By borrowing 20% less, you won’t be pushed to your financial max. This will give you the freedom to save more and reserve some cash for home improvements, furnishings, utilities, maintenance and any unexpected expenses that may arise.

Even if the bank thinks you’re good for it, avoid that extra 20% and the interest you’d have to pay on it. Your future self will thank you.

Put down 20%

Thanks to the tougher lending rules that resulted from the last economic downturn, “interest only” and 0-10% down-payment programs are a bit scarcer now — which is good for the economy and for you.

When you put 20% down, you borrow less. This gives you more affordable monthly mortgage payments and decreases the interest you’ll pay over the life of the loan. It also infuses instant equity into your home and gives you a safe place to park your cash as the market gains over time.

Give yourself 20% more space

Real estate experts will tell you that you should only buy a home if you can commit to staying there for five to seven years. That’s the amount of time, on average, that it takes for owners to recoup their closing and moving costs via normal home value gains.

But no matter your stage in life, five to seven years is a long time. You can’t really predict what’s going to happen within that time frame, including changes to the size of your family.

That’s where the 20% rule comes in: If you’re on the younger side, buy a home that’s got 20% more space than you need right now. You want some wiggle room to accommodate a growing family, because if you think moving is hard, try doing it with a 2-year-old — it’s not for the faint of heart.

You can also apply this rule if you’re past your child-rearing years by buying 20% less house than you needed before. Yes, you may want room for the kids and grandbabies to stay when they visit, but day to day, you’ll have 20% less space to heat, cool, clean and maintain. That gives you more financial freedom to enjoy life outside the four walls of your home on any income.

No matter what the real estate market, 20% is an important number to remember. Stick to it, so you can buy safely and securely.

Mazen Fawaz is the founder of OpenHouse, a real estate agent search company based in Santa Monica, California. OpenHouse is a NerdWallet business partner.