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 wonder how much of a down payment is best. A financial adviser might tell you that you should make a 20% down payment on any home you buy, because you avoid the additional cost of private mortgage insurance, and may secure a lower interest rate and 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 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 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 that much.

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

Financial Impact of Different Down Payment Amounts

Even though you don't necessarily have to make a 20% down payment on a home, putting down less may leave you with larger mortgage payments. That’s because you're borrowing more, and you may be looking at PMI.

Here's an example. Say you're buying a $300,000 home, and are signing a 30-year mortgage at 6.5%. If you make a 20% down payment of $60,000, monthly payments are about $2,052, of which $1,516 is principal and interest on your loan.

But watch what happens if you only put 3% down, or $9,000. In that case, you have a monthly payment of $2,619, of which $1,839 is principal and interest. You might also pay $245 a month in PMI.

So in this example, your monthly costs could be $567 higher with a 3% down payment compared to 20%.

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 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, which allow for 0% down

• VA loans, which allow for 0% down

• Jumbo loans, which may allow for as little as 10% down

Keep in mind that these loan programs have specific requirements. VA loans are only available to eligible members or veterans of the U.S. military or their surviving spouses, while USDA loans can only be used for homes in qualifying areas (for the most part, rural). 

It’s also worth noting that while VA and USDA loans don’t have a minimum credit score requirement, lenders that offer these loans can set their own requirements. FHA loans, meanwhile, have a minimum credit score requirement of 580 if you’re only making a 3.5% down payment. If you put 10% or more down, you can apply for an FHA loan with a credit score of 500.

With a conventional loan, the minimum credit score is typically 620. But even if you have a score that high, in some competitive real estate markets, a 20% down payment may help you win a bid. 

Some mortgage lenders might require you to put down 20% for different reasons, such as concerns about your income. You may also be asked to put down 20% on a second home. However, in many cases, you can put down less than 20%. Even if your conventional mortgage lender won’t accept a 3% down payment, they may let you put down 5% or 10% at closing. 

The higher the down payment you’re able to make, the more likely you are to qualify for a mortgage, since it means your lender is taking on less risk. You’re also taking on less risk by starting out with more equity in your home. 

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:

• Lending programs with low down payment requirements generally have a maximum loan amount that could make homes in high cost-of-living areas ineligible. 

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

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 still some benefits to putting down less. First, putting down less means you have more funds for unexpected costs. Homes have a way of needing surprise repairs, and maintenance costs can be higher than expected. It’s good 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. 

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 hope 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 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 for you. 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 local salaries. You may be able to make a 20% down payment in a more-expensive part of the country if your income matches the real estate values. 

What monthly payment can I afford?

As a 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 to bring 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 can 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 could build 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 may need that money for an unexpected expense.  

Should I make a 20% down payment if I have other debt?

Whether you should put down 20% when you have other debt depends on the type of debt you're carrying, and what it costs you. If it's high-interest debt, you may want to prioritize paying it off, even if it means putting down less than 20% on a home. Once you've repaid that debt, you can put more money into your mortgage, and get rid of your PMI.

Will I qualify for a mortgage if I have other debt?

Lenders use your debt-to-income ratio to see if you qualify for a mortgage. That ratio measures your total monthly debt payments relative to your income. Having other debt doesn't necessarily mean you won't qualify for a mortgage. But if you have too much debt, you may have trouble getting approved.

Looking for debt relief in Tucson, AZ or across the country? The first step is the most important one—learn more.

Down Payment Assistance Programs and Alternatives

If you're struggling to come up with any down payment amount, help may be available. Consider looking into down payment assistance programs. These are typically available at the state or local levels.

A good place to start is this list of state housing finance agencies. They can point you to programs in your state or community. Similarly, your county website may have information on down payment assistance programs. And some mortgage lenders or banks may be able to give you that information, too.

Keep in mind that many down payment assistance programs are geared toward first-time home buyers. However, some programs consider you a first-time buyer if you haven't owned a home in the past three years. 

There may also be down payment assistance programs geared toward specific groups, regardless of homeownership history. For example, you may find a program that caters to educators, medical professionals, or people who work in public service.

The Bottom Line on 20% Down Payments

Every person’s financial and life situation is different. For some buyers, a 20% down payment makes sense. Others might find that amount out of reach. Take a close look at your finances before purchasing a home, and figure out the right choice for your circumstances. Think about which scenario you’re more comfortable with:

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

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

One final pro tip. If you pay less than 20% and have to buy PMI, you can get rid of that extra expense 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 if your home’s value rises, and as you make mortgage payments. In some cases, your mortgage lender cancels PMI when the time comes. In other cases, you need to refinance to a new loan. In either case, PMI is a temporary expense, and doesn’t have to be your deciding factor.