Many people believe that before buying a home, they’ll need to have 20% of the purchase price ready in cash to use as a down payment. That can make the possibility of home ownership seem overwhelming, as even buying a small property priced at $80,000 means needing $16,000 in cash at the ready, a difficult sum for many households to save.
But the notion that homebuyers need to put down 20% is a common misconception. There are lenders that can help you get a mortgage if you don’t have that much saved for the down payment. Depending on your situation, it may even be possible to get a mortgage without putting any of your own cash on the line.
However, just because you can potentially buy a house or apartment without putting down 20% doesn’t mean you necessarily should. Let’s take a look at the advantages and disadvantages and see if it still makes sense to make a 20% down payment when you buy a home.
It may seem like everyone who buys a home puts down at least 20% of the purchase price, but the statistics show it’s not quite that simple. According to a recent report from Opendoor, 35% of baby boomers are far more likely to put down 26% or more on their next home, compared to only 11% of millennials and 14% of Generation X, who both said they’d put down less.
In fact, not even a majority of recent buyers are putting down 20%. According to the most recent Realtors Confidence Index by the National Association of Realtors, 52% of all noncash buyers put down less than 20% on their home purchase in October of last year, and a whopping 74% of first-time buyers made a down payment of less than 20%.
“While making a down payment of less than 20% does lead to higher interest rates and larger monthly payments, if it allows you to buy a home sooner, you do get the benefit of starting to build equity in your home more quickly,” says Nadia Aziz, GM of Home Loans at Opendoor.
According to Aziz, many lenders have products that allow customers to pay as little as 3% down. The US Department of Agriculture (USDA) and Veterans Affairs (VA) both even offer loans with zero down payment options, though these aren’t available to everyone.
But of course, there are downsides to putting down less than 20%. You’ll have less equity to start — meaning the portion of your home that you own outright, rather than the bank having an interest in it — and a bigger mortgage. That means your monthly payments will be higher. And putting down less than 20% can have other ripple effects as well.
To understand how your down payment influences the types of loans you may be offered when buying a home, let’s start with how lenders assess a borrower’s risk. One of the factors lenders consider is the LTV (loan-to-value) ratio, which is the amount you’re borrowing versus the amount your home is worth.
So if your mortgage is $80,000 and your home is worth $100,000, your LTV is 80%. The lower your LTV, the less risky the mortgage is for your lender and the more likely you are to get favorable loan terms.
Since a larger down payment resulting in a lower LTV ratio can help you qualify for lower interest rates, Aziz says it may be worth scraping together enough cash to make a larger down payment, even if it means getting family members to help out.
“The down payment can be made through the borrower’s own savings and assets, or in some cases, lenders will accept the down payment being made via a gift from a family member,” she adds, though a gift would need to be accompanied by documentation from the family member describing their relationship to the borrower and the purpose of the gift.
A gift from a family member can be one way to make it to the 20% down payment threshold.
In most cases, with a down payment of less than 20% on a conventional loan, you’ll also be on the hook for private mortgage insurance, or PMI. This is essentially an additional monthly charge on top of your mortgage payment that covers the cost of insurance in the event you default on your loan. According to LendingTree, PMI typically ranges from 0.15% to 1.95%, but can reach 2.5% or more.
“From the lender’s perspective, your down payment of less than 20% makes lending money to you more risky, and the monthly PMI payments compensate the lender for taking on that higher risk,” Aziz explains.
PMI is designed to protect the lender in case you default on your mortgage, meaning you don’t personally get any benefit from having to pay it. So putting more than 20% down allows you to avoid paying PMI, lowering your overall monthly mortgage costs with no downside.
Aziz says for a conventional loan, you can request that your monthly PMI payments stop once your LTV ratio drops far enough. “PMI should automatically drop off when the loan-to-value reaches 78%. For an FHA loan, you will need to pay the PMI — the FHA calls it the mortgage insurance premium, or MIP — for the duration of the loan,” she adds.
Obviously, the biggest advantage of not making a 20% down payment is that you don’t have to come up with as much cash to buy a home. But what are the advantages of putting 20% down?
- Smaller mortgage loan. Making a larger down payment translates to a smaller mortgage balance to pay off over time. “In the event that market values decline, having put down a larger down payment can help you preserve equity,” says Aziz. Putting down 20% or more could also make a difference when it comes to refinancing or selling your home down the road.
- Pay less interest over time. Aziz says locking in a lower mortgage rate and reducing your mortgage balance will bring down the total interest you’ll pay over the life of your loan. To determine your savings, use a mortgage calculator when evaluating how much money a 20% down payment can save you over time.
- Lower monthly payments. Putting down 20% results in smaller mortgage payments, since you’re starting off with a smaller overall mortgage. It also saves you from the added expense of PMI.
- Greater purchasing power. A higher down payment mean you can afford to buy a more expensive home. For example, Aziz says if you’re budgeting for a $1,000 monthly mortgage payment and can get an interest rate of 3% on a 30-year mortgage, with a 5% down payment you could afford to buy a $171,000 home, which would include roughly $685 a month for principal and interest, about $90 in PMI and the remainder for taxes and other expenses. But with a 20% down payment, a $213,000 home would fit into your budget for that same $1,000 monthly payment, since you wouldn’t have to pay PMI (though you would have higher property taxes on a more expensive property).
- Greater loan options and terms. Tony Grech, a senior mortgage loan originator at Luxury Mortgage in Southfield, Michigan, says the higher your down payment is, the more flexibility you’ll have in terms of loan amounts and loan programs. “Most loans over the conforming limit (jumbo loans) will require at least 20%,” he explains. “And most ARM (adjustable rate mortgage) programs don’t start to offer lower rates than fixed until you get to at least 20% down.”
Everyone’s situation is different, and while a 20% down payment is the ideal, it isn’t necessarily required.
A 20% down payment is a significant amount of money for most people. According to Opendoor’s report, 82% of Gen Xers and 93% of millennials say they’d need to save up for a down payment. For some people, it can make more sense to put down less and accept a higher interest rate and monthly payment if it means building equity in a home instead of paying rent elsewhere.
But putting down 20% or more is an important goal for those who want to spend less overall on their mortgage. “It can make the home more affordable by helping you save money over time with lower interest rates and monthly payments,” says Aziz.
So while making a 20% down payment isn’t a hard-and-fast requirement when it comes to buying a home, it’s a good idea if you can pull it off. But don’t assume that you’ll be locked out of the homebuying market just because you don’t have a lot of cash. Instead, look at your options and consider whether making a down payment of less than 20% makes sense for you.
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