Money Health

Do You Really Need a 20% Down Payment?

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Whether you’re a first-time home buyer or looking to move from your current home, you may be wondering how much of a down payment you need to make. Traditionally, a financial adviser might tell you that you should make a 20 percent down payment on a home. This will allow you to avoid the additional cost of private mortgage insurance and help you secure a lower interest rate and an affordable monthly payment.

However, most Americans don’t make a 20 percent down payment on their home. In fact, according to a recent survey from Freedom Debt Relief, 41 percent of homeowners made a down payment of 5 percent or less.

We’ll take a look at the reasons why a 20 percent down payment is a common rule of thumb when buying a home, including sage advice from mortgage experts.

The consequences of putting down less than 20 percent

While it may be a smart choice to put a 20 percent down payment on a home, many lenders will still lend to you even if you can’t put that much down. However, there are some negative consequences if you choose not to:

  • You’ll have to pay private mortgage insurance (PMI)
  • Your interest rate could be higher
  • Your monthly payment might be more than expected
  • You may not get approved for a mortgage

To better understand the factors you should consider when choosing how much of a down payment to make, we interviewed mortgage experts at Landed.com, a company that helps educators buy homes in expensive areas. Here’s what they had to say:

Is a 20 percent down payment on a home necessary?

Jess Zhao, Head of Customer Experience at Landed:

“The mortgage industry is primarily structured around providing 80 percent mortgages, which are generally perceived by lenders to be less risky than larger ones. However, there are options for hopeful homebuyers who want to put less than 20 percent down.

These options include the Federal Housing Administration (which insures loans that require as little as 3.5 percent down), national and regional programs, and options for specific types of professionals. Some lenders offer loans with less than 20% down, but these options are typically more expensive.

When you put less than 20 percent down, many lenders require that you buy private mortgage insurance (PMI), which protects your lender if you default. This is expensive and can cost a few hundred dollars each month. Some lenders don’t require PMI but instead charge a higher interest rate.

Another benefit to putting 20 percent or more down is that you make smaller monthly payments because you’ve taken out less debt. Also, in expensive real estate markets, putting 20 percent down may be necessary to help you compete for homes.”

What should you consider when deciding on a down payment?

Jesse Vaughan, Landed Co-Founder:

“A larger down payment reduces the amount you need to borrow. The more you put down, the smaller your loan will be; this means you pay a smaller amount in interest over time and have lower monthly payments. Also, lower monthly payments can assist with your future borrowing power by improving your debt-to-income ratio.

In the expensive areas, it’s often not a viable option to put less than 20 percent down. But it may be possible in less expensive areas, even less than 10 percent down. Reasons a homebuyer may decide to do this include that you can buy a home more quickly without saving for that intimidating 20 percent, and you can have more cash reserves available later in case of an emergency (or an exciting opportunity).”

How does the location of your home impact your down payment?

Jesse Vaughan, Landed Co-Founder:

“In expensive areas, it’s often not an option to put less than 20 percent down. This because of two key factors:

  1. Low down payment lending programs generally have a maximum loan amount that would make most homes in places like the San Francisco Bay Area ineligible for the program.
  2. Due to the highly competitive nature of the home purchase market, buyers with lower down payments can be seen by sellers as riskier offers to accept.

Even individuals who have 20 percent down for their dream home may be continually outbid by all-cash offers.

It takes about seven years to save for a 20 percent down payment on a home (median valued) in the United States, but it really depends on where you live. For example, it takes less time than it did 30 years ago to save for a down payment in Austin, TX, but takes 13 years longer in San Jose, CA. The median valued home in San Jose is worth about $1.2 million (as of March, 2019). Given that the median household income is around $100,000, a homebuyer would need to put down over $600,000 to be able to afford the monthly mortgage.”

How does your home’s potential appreciation impact your down payment?

Annie Vasishta, Homebuying Programs Lead at Landed:

“How much you put down is ultimately related to why a homebuyer is buying a home and what’s most important to them. For example, if I was looking to purchase my forever home near top-performing schools, I may want to put a higher down payment down because this is a long-term investment in an area that will likely continue to appreciate.

If I was looking to buy a ‘starter home’ anywhere, I can afford to put down a lower down payment because it is a short-term investment vs. a long-term investment for me. Similarly, if you look at the market and see that housing prices have consistently appreciated, you may be willing to be more competitive as the purchase may be less risky for you. So, to sum it up, it’s really up to the buyer to define their buy box and determine how much they want to put down.”

Do you have any other advice for homebuyers?

Jesse Vaughan, Landed Co-Founder:

“For most of us, buying a home is the largest financial investment we will ever make. As you decide your down payment amount, make sure you’ve defined your specific goals in buying a home first. What are you looking to achieve as a result of your home purchase? If one of your goals is to build financial security (and to only spend a certain amount of your savings on the home right now), use that as a filter for your decision.

Remember that you don’t need to do all this work alone, either. Make sure your real estate agent understands what you’re looking for in a home purchase price, as well as your lender, family, and trusted advisors.”

Jess Zhao, Head of Customer Experience at Landed:

“Keep in mind that you’ll need cash on hand to cover closing costs as well as your down payment. Closing costs are one-time costs associated with closing the transaction, paid before you get the keys and close on your new home. You typically won’t know exactly what your closing costs are until a few days before you officially close. Most Landed homebuyers have found that these fees are about 1 to 2 percent of the total cost of the home, which can be a significant expense.”

20 percent down payments: The bottom line

Making a 20 percent down payment on a home is a smart decision if you want to get a low interest rate on your mortgage and have affordable monthly mortgage payments. However, this might not be possible if you live in an expensive area or you’re having trouble saving enough money to hit that 20 percent goal.

When deciding how much of a down payment you should make, consider the following factors:

How much do homes cost in your area?

There are many real estate apps which allow you to look at home prices in your area and let you see how much your mortgage cost would be based on the down payment you can afford.

What can you afford to pay each month?

Just because you don’t have 20 percent in savings doesn’t mean you can’t afford a home. If you can put 5 to 10 percent down and still afford your monthly mortgage payments plus PMI and any other fees, it may be safe for you to purchase a home. Creating a monthly budget will help you determine what you can afford.

Could you cover an emergency expense on top of your new mortgage payment?

Whether you own a home, emergencies happen. So even if you do have that 20 percent down payment saved, you need to make sure you can handle an emergency expense on top of your mortgage. If your monthly mortgage payments are so high that you wouldn’t be able to cover an unexpected expense like a new roof, a hospital stay, or a loss of income, you may want to hold off on buying a home.

Every person’s situation is different. For some, making a 20 percent down payment is the right decision. For others, it’s an unachievable goal. That’s why it’s crucial to take a hard look at your finances before you purchase a home and figure out just how much you’re willing to spend to bring your dream of homeownership to life.

Plan today for a brighter financial future

Whether you’re just learning how to make a budget or saving for a 20 percent down payment on a home, planning for your future doesn’t need to be hard. We have developed a helpful guide that can help you move toward a better financial future. Get started by downloading our free guide right now.

John Russo is a Creative Manager at Freedom Financial Network. His goal is to make the world of personal finance more accessible so that everyday people can find the right financial solutions for themselves. In his free time, he enjoys hiking, reading pretty much anything, and spending time with his fiancée and two cats.