Several generations ago, lenders required home buyers to have a 20 percent down payment in order to get a mortgage. While there were a few options out there for people who couldn’t save this substantial amount, the reality was that for the majority of people, the 20 percent down was a requirement.
It was the way to show that you were financially responsible enough for home ownership. And it was a strong way that the banks felt secure in making a home loan.
Today, however, home buyers have many options available to them as they shop for a new home, and those mortgage options mean that the 20 percent down payment is no longer as much of a requirement. For most buyers, especially those who do not have the equity of an existing home to help with their purchase, the 20 percent down payment is not even a possibility.
Yet for those who can do so, putting 20 percent down carries some benefits worth considering. Here is a closer look at when the large down payment makes sense, and what the potential drawbacks are that buyers should consider.
How The 20 Percent Down Payment Helps
When it is possible for the buyer to save enough, the 20 percent down payment does have some benefits that are worth considering. First, when you are able to save 20 percent, you can get a mortgage that has no private mortgage insurance or similar fees. Because lenders consider a borrower with less than 20 percent for the down payment to be higher risk, they charge additional fees to serve as insurance on these loans.
Putting 20 percent down also means you are borrowing less. Because every dollar you borrow will be charged interest, the less you borrow the lower your repayment costs should be over the life of the loan. This could improve your monthly cash flow as well. If you have the ability to save 20 percent, this is a benefit worth considering.
The Drawbacks Of 20 Percent Down
While saving 20 percent does have some benefits, it also has drawbacks that you must also consider. First, 20 percent of a home loan is a significant amount of money. On a $200,000 house, that means you have to save $40,000. For the average home buyer, this represents years of saving. And you could be giving up years of price appreciation in addition to the money you have lost by paying rent. In our current low-yet rising- interest rate environment you could be setting yourself up for a higher cost of ownership as well.
If you are putting all of that money down as your down payment, you may find yourself cash strapped for other home buying costs, like new furniture, repairs or closing costs on your mortgage. The Consumer Financial Protection Bureau warns that this can be a significant downside, especially for first-time buyers who have a lot of expenses as they make the move into their first homes.
For most of us it is critical to set aside money for savings, pay off high interest rate debt, and to save for retirement and other future planning/savings vehicles. Many people find themselves digging into their other investments, like their 401(k), to come up with the money for the down payment. Borrowing funds from a 401K can sometimes be useful, but withdrawing funds prematurely can be detrimental to one’s future. Paying a bit more in interest over the life of a mortgage is often better than creating a serious financial bind for your future needs.
Finally, saving 20 percent often means you can’t buy a home quite as quickly. Since home prices historically tend to rise, not fall, the longer you wait, the more you may spend on your home. If home prices rise by 5 percent a year, which is fairly standard, waiting two years to purchase the home means $20,000 in extra costs for a $200,000 home. The higher purchase price counters any savings you may have when you put down 20 percent.
Can You Buy With Less Than 20 Percent Down?
So can you buy a home with less than 20 percent down? The answer to that question is yes, and often it makes more financial sense to do so. In fact, according to Freddie Mac, 40 percent of home buyers in today’s markets are making down payments of less than 10 percent. So if you are going to buy a primary residence home without saving the 20 percent, what are your options?
• VA and USDA loans allow qualified borrowers to finance up to 100% of the
purchase price of a primary residence.
• Freddie Mac and Fannie Mae have first time home buyer programs that allow up
to 97% financing.
• FHA loans will finance up to 96.5% of the purchase price for a primary residence.
• Conventional loans allow you to finance up to 95%.
• Down payment assistance is another option to consider. These programs, which
are available through nonprofit organizations or government-run programs
(NCHFA is an example), give homeowners a hand in coming up with the down
payment they need to purchase the home.
• Lenders are still offering piggyback loans. These loans allow you to take out a
smaller loan for part of your down payment, then a traditional loan for the rest of
the purchase price. You may still need about 5 percent of your own money to put
down on the purchase. Then you can work with your lender to borrow 15
percent with a smaller, and many times shorter-term loan, and the remainder with
a conventional mortgage.
While some of these home loans do have additional costs, like the funding fee for the VA loan or private mortgage insurance for conventional low down payment loans, they give you the ability to buy now without 20 percent down so you can start enjoying the benefits of home-ownership sooner.
The Bottom Line
Everyone’s financial situation is different. Getting sound financial advice is always wise. Whether you choose to put
down a large amount on your home or take advantage of these different loan options to buy with a smaller amount
down, make sure you weigh your options before making your choice.