It’s a myth that you need a 20% down payment to buy a home no matter what. The market is changing fast and the rules around how to buy a home and secure funding are changing with it.
Of course, there are good reasons to make at least a 20% down payment—if you can do so comfortably. It will reduce how much you’ll be borrowing, so your monthly payments will be lower, and smaller monthly payments make it easier to qualify for a mortgage in the first place.
In this article, we’ll discuss when and why it became standard to provide a 20% down payment, plus how to avoid paying so much without sacrificing your homebuying goals.
First, let’s discuss what a down payment is and how it works.
Down payments, explained
Buying a home is different from buying any other product. Instead of paying the whole price right away, buyers usually pay a percentage of the price up front and borrow the rest from a mortgage lender. A down payment is the amount of upfront cash a buyer pays for a home before a mortgage lender provides funds to make up the difference.
The effects of your down payment on mortgage
Lenders generally offer lower interest rates to buyers who can pay a higher down payment, because they see these borrowers as less of a risk. The idea is that if you have more money saved for a down payment, you’ll have more money to pay over the course of a long-term mortgage.
Put another way, that means that if you choose to save money up front by providing a smaller down payment, you could end up paying more over time in interest.
The 20% down payment myth
For a long time, the industry standard for a down payment on a house was 20%. That’s because run-of-the-mill banks used to be the main source for home loans, and couldn’t afford to own homes that borrowers defaulted on. They cleared their books of these homes by offering them to new buyers at a 20% discount, so long as the buyer could make up the difference in cash.
But the real estate industry has changed a lot since then. Home prices are higher than ever, and mortgage companies are now one of the main sources of home loans and they are specifically prepared to offer mortgages with a lower down payment.
Why 20% down is not right for everybody—and how you can pay less
Yes, paying more money up front lowers your interest rate—but it also means you’ll spend more right away. You’ll save money over time, but a lot can happen with your home in the average 30 years that a mortgage takes to pay off.
Here’s why paying 20% down may actually be a liability to a homeowner:
A higher down payment means a lower rate of return on your investment
Homes are a great investment. So, even though you may be understandably sentimental about it, it’s important to also think of it as a potential financial asset. And it’s less of an asset if you put more money into it up front.
Homes appreciate in value about 5% a year in a healthy economy. So it’ll take four years for a home’s increased resale value to be 20% higher than what you bought it for. If you put 20% down, you could sell the home then and break even. But if you paid less up front, you’ll have a higher rate of return, because that 20% increase in your home’s value is higher than your initial investment.
Let’s look at an example:
If you put 20% down for a $400,000 home, you’ll pay $80,000 in cash first. After four years of 5% growth, your home is now worth $480,000—your rate of return is 100%.
But what if you made a lower down payment?
If you put 10% down for the same $400,000 home, you’ll pay $40,000 in cash first. After four years of 5% growth, the house is worth $480,000—your rate of return is 150%.
Interest rates affect these numbers. If you paid a lower down payment, your interest rate is higher so that, when you sell, you’ll owe a little more back to the bank. Generally, the rule of thumb is that while a lower down payment may increase your interest rate, it also will increase your rate of return.
A higher down payment means you’ll lose more if the economy slows down
Remember, you don’t get your down payment back. So, no matter how much you sell your home for down the road, subtract your down payment from your overall proceeds.
It’s a safe bet that your home will increase in value enough to cover the cost of your down payment, but that always depends on the market which isn’t always predictable.
For example, in 2008 the real estate market crashed and homes lost much of their value very quickly. Since then, the market has recovered, but not before a lot of people found themselves underwater on their mortgage. The sting was even greater for the homeowners who paid the full 20% up front.
Higher down payments are riskier if you’re underwater on your mortgage
If the market nosedives (like in 2008), you may end up underwater on your mortgage and owe more on your loan than the home is worth.
But you’ll be at less risk of losing your home if you paid a lower down payment.
If a bank has to foreclose, they’ll foreclose on a home with higher equity first. And there is more equity in the home if you paid a higher down payment, because more of the home loan is paid off.
For a deeper dive on how equity works, read our article here. But remember, that equity is the difference between how much you owe on your loan and how much you would be able to sell your home for.
The bank doesn’t want to foreclose on homes with less equity, because they would end up taking on more of a loss if they were forced to sell it themselves in a down market. It’s in their best interest to work with you to keep your home until the market recovers and you build more equity.
How to pay less than 20% on a down payment
Of course, for many homebuyers, 20% is simply too expensive. Home prices are getting higher every year, while inventory bottlenecks due to population growth and supply-chain issues.
But just because you don’t have 20% of a home’s list price doesn’t mean you can’t afford to buy and own. There are plenty of options for qualified buyers to purchase their home, even if you don’t have the full 20% to pay up front.
Private mortgage insurance
If you pay less than 20% down for your home, lenders will require you to pay private mortgage insurance (PMI). It’s the most common tool a lender has to loan a mortgage to a buyer with a lower down payment (without taking on more of the risk themselves).
With PMI, a borrower will pay a monthly fee into the insurance policy so that if you do default, the lender is protected and can cash out on the policy. While PMI is designed to insure the lender, it is an important tool every buyer has that allows them to secure a loan even if they don’t have 20% to pay up front.
The Federal Housing Authority provides home loans to low- and moderate-income families with down payments as low as 3.5%. Your mortgage insurance premiums may be higher than those with a traditional loan, and you’ll need a credit score of at least 580 to qualify, but FHA loans have historically helped families enter into the housing market and begin to build equity.
The US Department of Veteran Affairs offers home loans to active or retired military personnel (or their surviving spouses) with no money down and great interest rates. The only downside to this loan is that they require an activation fee of 2.3% of the whole loan amount. But you can pay that up front as a down payment or rolled into your monthly payments.
The US Department of Agriculture offers rural development home loans if you’re buying in a town of 10,000 people or less. The interest rates for these loans are often competitive, too. But closing costs tend to be a little higher with an added 2% mortgage insurance premium at closing plus premium payments throughout the life of the loan.
Down payment assistance programs
There are thousands of down payment assistance programs available at the local, state, and federal level. These usually come in the form of grants, rewards, and other public service funds for medical professionals, teachers, students, and more. Check with your lender to see what options are available in your area.
Wrapping it up
Not only is it possible to pay less than 20% for your home down payment, but in some scenarios it’s a better choice. You can see now how much the benefits of a lower down payment may outweigh the costs. Between getting a better interest rate, freeing up cash for other things, and the ability to lower your savings target, making a lower down payment may be right for you for a lot of reasons. Your lender will help you make the best choice for your specific scenario.
Can you get a mortgage without 20%?
Absolutely. There are lots of different options, each with their own pros and cons, but you can buy private mortgage insurance, apply for a down payment assistance program, and utilize specialty loans from the VA, USDA, or FHA.
How can you avoid paying PMI with a down payment lower than 20%
It’s easiest to just pay the PMI because it’s not permanent anyway—you can stop paying when the home’s value rises enough so that the loan-to-value ratio is 78%. But you can also take out a second mortgage, or piggyback loan, that covers the difference between your down payment and how much money is required to reach 20%.
How do you qualify for an FHA loan?
You’ll need a credit score of 580 for the lowest down payment option. After that, the lower the credit score, the higher your down payment will have to be. You’ll also need verifiable employment and income that proves your mortgage payments won’t exceed 31% of your gross pay.
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