Do You Really Need a 20% Down Payment?

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 should make. A financial adviser might tell you that you should make a 20% down payment on any home you buy. This allows you to avoid the additional cost of private mortgage insurance and could potentially help you secure a lower interest rate and a more affordable monthly payment.

However, few Americans make a 20% down payment on their home. According to a recent survey from Freedom Debt Relief, 41% of homeowners made a down payment of 5% or less. And depending on the type of mortgage you get, you may not need to make anywhere close to a 20% down payment.

We’ll take a look at the reasons why a 20% down payment is a common rule of thumb when buying a home, and why it might not always apply.

What Happens If You Put Down Less Than 20%?

Making a 20% down payment on a home could lead to more manageable mortgage payments. But it may be possible to get a mortgage with a lot less money down if you can’t comfortably afford a 20% down payment.

If you don’t make a 20% down payment, here’s what could happen:

• You might have to pay for private mortgage insurance (PMI)

• Your interest rate could be higher

• Your monthly payment might be higher than expected

• You may not get approved for a mortgage

You May Like These

Is Severance Pay Taxable? How Job Loss Affects Your Taxes

What Is Personal Finance?

How to Pay Less for College—What You Need to Know

Is a 20% Down Payment On a Home Necessary?

Though it’s certainly not bad to put a 20% down payment on a home, it’s not always necessary. Many conventional mortgage lenders will accept as little as 3% down on a home. Many loan programs have a lower down payment requirement. 

These options include:

• FHA loans, which require as little as 3.5% down, depending on your credit score 

• USDA loans

• VA loans

Even so, in some competitive real estate markets, a 20% down payment may be necessary to help you win a bid. Some mortgage lenders might require you to put down 20% for different reasons, such as concerns about your income. 

How Does The Location Of Your Home Impact Your Down Payment?

The market where you’re trying to buy a home typically plays a part in whether you can make a down payment of less than 20%. In expensive areas, you may have a harder time making less than a 20% down payment for a couple of reasons:

• Low down payment lending programs generally have a maximum loan amount that could make homes in high cost-of-living areas ineligible for the program. 

• In a highly competitive market, sellers could view buyers with lower down payments as riskier offers to accept.

What Are The Benefits Of Making Less Than a 20% Down Payment?

A 20% down payment could help you avoid PMI and mean lower monthly mortgage payments, but there are benefits to putting down less. First, putting down less means you’ll have more funds for unexpected costs and any unplanned expenses.

Homes have a way of needing surprise repairs, and maintenance costs can be higher than expected. It’s a good idea to have extra money in your emergency fund for this purpose.

Homes are considered an illiquid asset, which means it’s hard to turn a home into cash quickly. The more money you put into your home, the less liquidity you have overall. 

Should The Type Of Home You’re Buying Affect Your Down Payment?

You might take a different approach to your down payment if you’re buying a starter home rather than a forever home. With a starter home, you might decide on less than a 20% down payment. If you’re hoping to upsize in a few years, you may not want to tie up your cash.

On the other hand, if you’re buying your forever home, your goal is to be mortgage-free eventually. The more money you put down at closing, the easier it becomes to pay off your home and own it outright.

The condition of the home might also be a factor in the size of your down payment. A fixer-upper may need more money in the near term for repairs and improvements. In that case, a smaller down payment could make sense. 

Questions To Ask Yourself When Deciding On Your Down Payment

Making a 20% down payment on a home has benefits, but it may not be the right choice for you. If you’re not sure if you should put down 20% on a home, ask yourself the following questions. 

How much do homes cost in my area?

Finding out home prices online or working with a local real estate agent can help you figure out what a 20% down payment on a home in your area looks like. From there, you can figure out if it’s realistic. In a market where the average home price is $750,000, saving a 20% down payment may be more challenging than in an area where home prices average $300,000. 

Sometimes higher home prices correlate with higher salaries. You may be able to make a 20% down payment in a more expensive part of the country if your income is higher. 

What monthly payment can I afford?

As a general rule of thumb, it’s a good idea to keep your monthly housing costs to 30% of your take-home pay or less. And that 30% should ideally include recurring costs like homeowners insurance and property taxes.

If you don’t make a 20% down payment, you could be looking at higher monthly mortgage payments that force you to spend more than 30% of your pay on housing. If that’s an uncomfortable thought, and if you can manage the 20% down payment, consider doing so and bringing down your monthly payment. 

Before you settle on a down payment, create a monthly budget that accounts for all your expenses. That should help you decide what housing payments you should take on.

Will waiting to save up a 20% down payment force me to delay homeownership longer than I want to?

Saving a 20% down payment could take years. If you’re ready to become a homeowner, it could pay to put down less than 20% to get into your home sooner. Also, the sooner you buy, the sooner you can start building equity. 

Other factors, like renting with unpredictable increases and renewals, might also motivate you to speed up home-buying and put down less than 20%. 

Will making a 20% down payment leave me without a strong emergency fund?

When you own a home, emergencies can happen. 

Everyone needs an emergency fund for unplanned expenses. That way, when you’re hit with an emergency car repair or an unexpectedly large vet bill, you’re covered. 

But it’s usually not a good idea to use your emergency fund for a down payment, since you could need that money for an unexpected expense.  

The Bottom Line On 20% Down Payments

Every person’s financial and life situation is different. For some buyers, a 20% down payment is possible and makes sense. Others might find that amount out of reach. Your best move is to take a close look at your finances before purchasing a home and figure out the right choice for your circumstances. 

• Paying more upfront gives you smaller mortgage payments, and you’ll spend less on interest over the life of your loan. 

• If you start out with a smaller down payment, you’ll pay more each month and spend more on interest all-in. 

Think about which scenario you’re more comfortable with. 

One final pro tip. If you pay less than 20% and have to buy PMI, you can have that extra expense canceled once you have 20% equity in your home. Equity is the difference between your home’s value and the amount you owe on it. You build equity as your home’s value rises and as you make mortgage payments. In some cases, your mortgage lender can cancel PMI when the time comes. In other cases, you’ll need to refinance to a new loan. In either case, PMI is a temporary expense and doesn’t have to be your deciding factor.