Most people believe you need 20% down to buy a home. It’s not necessarily the case, though.
Is it nice to put 20% down on a home?
Do you need it?
Many loan programs require much less than 20% down. Some loans don’t require a down payment at all. However, there are benefits to making a larger down payment; if you can afford it, you may want to.
Here’s what to consider when choosing your down payment amount.
The 20% Down Payment Myth
Until 1956, banks required a 20% down payment. It was their only way to insure their investment in a home. This is because banks don’t want possession of homes; they aren’t in the real estate industry. Instead, they want to make interest on the loan, and that’s it.
In 1956, banks realized most people couldn’t make a 20% down payment, so the Private Mortgage Insurance industry was born. It replaced the 20% down payment requirement by requiring borrowers to pay for mortgage insurance to protect lenders if a borrower stopped making payments.
Today, you can find loans with down payment requirements as low as 3%, and if you’re a veteran or a low-income family borrowing in a rural area, a 0% down payment.
20% Down Payment Pros and Cons
Even though a 20% down payment isn’t required, that doesn’t mean it’s not a good idea. There are good and bad sides to putting down 20% on a home.
· You’ll avoid mortgage insurance
If you borrow a conventional loan and put down 20%, you won’t pay Private Mortgage Insurance. This means every dollar you put toward your loan covers the money you owe, plus the interest charges, instead of mortgage insurance that doesn’t even protect you.
· Better mortgage rates and terms
The more money you invest in a home, the better rates and terms lenders can offer. The more ‘skin in the game’ you have, the more likely you will make your payments. For example, if you had $1,000 invested in a home and had trouble affording the mortgage payment, you wouldn’t have much of a problem walking away because it’s only $1,000 you’d lose.
However, if you had $20,000 invested, you’d probably do whatever it took to make the mortgage payments to avoid losing your $20,000 investment. This is because lenders reward borrowers with higher down payments.
· Your monthly payment is lower
The more money you invest in your home, the less you must borrow. The lower your loan amount, the less you’ll owe each month. This provides more room in your budget, making it easier to afford your monthly bills.
· You can’t get the money back
The money you invest in your home is illiquid. This means you can’t get it back immediately should you have an emergency. Once you put money down on a home, it stays there until you sell it. A cash-out refinance may be an option after you own the home for six months, but you can only remove any equity beyond 20%, as lenders require 20% to remain in the home.
· It’s harder to save for an emergency
All repairs and maintenance fall on your shoulders when you own a house. If you put all your money into the home and don’t have enough to handle emergencies, it could cause financial issues.
· It can take longer to save
If you don’t already have money saved but want a 20% down payment, it could delay how long until you can buy a home.
Alternatives to the 20% Down Payment
While having instant equity in your home is nice, a 20% down payment isn’t required. Here are some alternatives.
· Piggyback loan – A piggyback loan is a first and second loan when you buy the property. It’s also called an 80/10/10. You borrow 80% of the home’s value with your first mortgage, 10% with a second mortgage, and make a 10% down payment. This avoids PMI and may help you get better rates and terms on your first loan.
· Make the minimum down payment – All loan programs except jumbo loans have an option to put down less than 20% on a home. You can put down as little as 5% with conventional financing and 3.5% with FHA loans. VA and USDA loans don’t require any money down.
What’s the Right Down Payment for You?
The right down payment is different for everyone. Look at your financial situation and ask yourself these questions.
· Do I have an emergency fund?
If you don’t have money saved for an emergency, don’t invest all of your money into the home. Ideally, you should hold three to six months of expenses in a separate savings account and/or have money to cover home emergencies.
· Have I saved for retirement?
Don’t put all your assets into your home. Instead, ensure you’ve started and contributed to a retirement savings account. Investing in a home can be a good investment, but it’s not liquid.
· Is a lower payment a better option?
Ask yourself if you need the lower payment or if you’d feel more comfortable having the money available should an emergency occur.
Most borrowers find a balance between the down payment and keeping some funds liquid. Keeping your payment low is ideal for most, but some borrowers prefer to have more money available should the unexpected occur.
So is a 20% down payment necessary? It’s not. But it’s nice and can get you the best rates and terms on your loan.
If you don’t have 20% to put down, don’t worry; many loan programs are available that require a much lower down payment. Talk with your loan officer about your options, and run the numbers to see the difference between a high and low down payment.