Money Health

Do You Really Need a 20% Down Payment?

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Whether you’re a first-time home buyer or you’re 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% down payment. This is a wise choice if you want to avoid the additional cost of Private Mortgage Insurance and you want to secure a lower interest rate and an affordable monthly payment.

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

While it may be a smart choice to put 20% down on a home, nowadays many lenders will still lend to you even if you can’t make a 20% down payment. 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:

Do You Really Need to Make a 20% Down Payment on a Home?

Jess Zhao, Head of Customer Experience at Landed:

“The mortgage industry is primarily structured around providing 80% mortgages, which are generally perceived by lenders to be less risky than larger mortgages. However, there are options for hopeful homebuyers who want to put less than 20% down, including the Federal Housing Administration (which insures loans that require as little as 3.5% down), national and regional programs, and options for specific types of professionals (such as Landed’s down payment program for educators). Some lenders offer loans with less than 20% down, but these options are typically more expensive.”

What Are the Benefits of a 20% Down Payment?

Jess Zhao, Head of Customer Experience at Landed:

“Saving up for a 20% down payment comes with a lot of benefits. One major benefit is that you don’t need to buy mortgage insurance. When you put less than 20% down, many lenders require that you buy private mortgage insurance (PMI), which protects your lender if you default on the loan. 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 if you put less than 20% down, which can also be very expensive.

Another benefit to putting 20% down (vs. 10% down, for example) is that you make smaller monthly payments because you’ve taken out less debt.

Finally, in expensive real estate markets, putting 20% 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.

With a larger down payment – such as 20% vs. 10% – you might qualify for a lower interest rate and you avoid private mortgage insurance (PMI), which can be a significant financial burden. You’ll have lower monthly payments, which 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% down […] But in less expensive areas, it may be possible to put less than 20%, or even less than 10% down. Reasons a homebuyer may decide to do this include that you can buy a home more quickly without saving for that intimidating 20%, 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% 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% down for their dream home may be continually outbid by all cash offers.

In the U.S., it takes about seven years to save for a 20 percent down payment on a median valued home. However, that timeframe may be significantly shorter or longer depending on where you live. For example, in Austin, TX, it takes less time than it did 30 years ago to save for a down payment in the area, whereas in San Jose, CA it takes 13 years longer. The median valued home in San Jose costs about $1.2 million. 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, which makes it very challenging to plan for them. Most Landed homebuyers have found that these fees are about 1% – 2% of the total cost of the home, which can be a significant expense for you and your family.”

20% Down Payments: The Bottom Line

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

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

How Much Do Homes Cost in Your Area?

Apps like Zillow allow you to look at home prices in your area. These apps also let you see how much your mortgage cost would be based on the down payment you can afford. Understanding this information could help you get an idea for how much you’d have to save in order to have a down payment and mortgage payment you’re comfortable with.

What Can You Afford to Pay Each Month?

Just because you don’t have 20% in savings doesn’t mean you can’t afford a home. Putting 20% down helps ease the burden of monthly mortgage payments. However, if you can put 5%-10% down and still afford your monthly mortgage payments plus PMI and any other fees, it may be safe for you to purchase a home.

Could You Cover an Emergency Expense on Top of Your New Mortgage Payment?

Whether or not you own a home, life happens. Emergency expenses happen. So even if you do have a 20% down payment, 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 the expense of a major repair to your home, a medical bill, or some other unexpected expense, you may want to hold off on buying a home until you have an emergency fund.

Every person’s situation is different. For some, making a 20% 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 home much you’re willing to spend to bring your dream of homeownership to life.

If you’re having trouble making enough of a down payment on your home, companies like Down Payment Resource could connect you with homebuyer assistance programs. These programs are designed to help you save for a home faster, access cash from state, federal, and municipal funds, or find assistance paying for closing costs. 

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.