The thought of paying 20 percent down on a new home can be daunting for many aspiring homeowners. But don’t let go of your dream just yet. While a 20 percent down payment was often required in the past, the average down payment on U.S. homes today is closer to 5-6%. So do you need to pay 20 percent down? Or can you get away with less? Let’s look at the pros and cons of a larger down payment. Then we’ll discuss some more affordable options, and show you how to decide which amount is right for you.
Do you have to make a 20 percent down payment?
According to the National Association of Realtors (NAR), the median home price nationwide at the end of 2018 was $235,000 (source). That means a 20 percent down payment would cost you $47,000. Paying 10% down would set you back $23,500, and 5% costs $11,750.
Why pay more upfront? Well, a 20% down payment ensures that you have a substantial invested interest in the property. In other words, spending more upfront reduces the risk for the lender, which allows them to offer you better rates and terms.
While a 20% down payment was once an industry-standard, times have changed. Although having a large stake in a property can be beneficial for both buyer and lender, many buyers can’t afford to put down that much upfront. As a result, lower down payments have become the new normal. However, to protect the lender’s interests, borrowers who pay less than 20% down are often required to pay for private mortgage insurance until they pass that 20% equity mark.
In summary, you don’t have to pay 20% down — but if you can afford to do, it will provide some benefits.
Benefits of a 20 percent down payment
Why should you consider putting 20 percent down on a house if you can? There are a few standout benefits.
First, by putting 20% down on a home, you instantly own one-fifth of it. This gives you more of a cushion against market fluctuations. If your home’s value dips (like many did during the 2008 housing crisis), there is a much smaller chance that you’ll end up owing more than the home is worth.
Putting 20% down means shrinking your loan amount by 20%, which will save you money in interest. Plus, a larger equity share lowers the risk for the lender, which usually translates into lower interest rates.
No private mortgage insurance (PMI) costs
Another benefit is that with a 20 percent down payment you won’t have to pay for PMI.
A PMI typically costs 0.5% to 1% of the loan amount per year. So if your loan is $200,000, your PMI could be $2,000 per year and about $165 per month.
Even if you can’t afford 20% upfront, you can still request to cancel your PMI once you’ve paid 20% of the property’s original appraised value.
Lastly, the more you pay down, the less you’ll owe on the home. And the less you owe, the lower your monthly payments.
Of course, your monthly mortgage payments will also depend on the length of your mortgage term. The longer the loan term, the lower the monthly payments, but you will pay more in interest.
Example: 20 percent down payment on a 200,000 house
Let’s look at the total cost difference between putting down 5%, 10%, and 20% of a loan amount.
In this example, let’s say the home costs $200,000, you have a credit score between 700 and 719, and you get an interest rate of 4.5%. For simplicity’s sake, we’ll use the same interest rate across the board. In reality, you’d likely get a lower interest rate with a larger down payment.
|Considerations||20% down||10% down||5% down|
|Down payment $ amount||$40,000||$20,000||$10,000|
|PMI costs per year||$0.00||$950||$1,350|
|Minimum PMI Costs (the PMI for the amount of time before you’ve paid 20% down)||$0.00||$5,700||$11,125|
|Monthly mortgage payment (principal and interest)||$810.00||$912.00||$962.00|
|Overall cost on a 30-year mortgage (360 monthly payments plus the down payment and PMI)||$331,600||$354,020||$367,445|
|Estimated additional cost compared to a mortgage with a 20% down payment||$22,420||$35,845|
If you put down 20%, you will save about $22,000 when compared to homebuyers who put down 10%, and about $35,000 more than those who put down 5%. Those are some serious savings. Of course, if you don’t have $40,000 to pay down, the higher costs may be worth it if it allows you to buy a home. Ultimately, it’s up to you to decide whether you’d rather lock down a home now or wait a few years to save up for a larger down payment.
Consider the opportunity cost of a large down payment
Paying a larger down payment will save you money on a mortgage. However, it also means you can’t use that money for other investments, such as starting a business, paying off student debt, or investing in your retirement savings. This is called the opportunity cost of an investment. Opportunity cost is the benefit you don’t acquire when choosing one investment over another.
Before you decide to invest your savings in a large down payment, consider how much you could realistically make by putting that money in your best investment option. Typically, the money you save when you don’t have to pay for a private mortgage insurance policy represents a better return than from alternative investments, such as bonds or stocks. However, this is not always the case, so it is important to weigh your options.
Lower down payment alternatives
What if you can’t afford a 20% down payment? Even if you don’t have the cash on hand for a large down payment, you still have options.
Federal Housing Association (FHA) loan
The FHA loan is a popular loan program backed by the Federal Housing Association. The program provides flexible eligibility requirements, including a 3.5% down payment for applicants with credit scores of 580 and higher, and a 10% down payment option for applicants with scores between 500 and 579. Note that lenders offering FHA loans will require you to purchase PMI.
Veterans Affairs (VA) loan
VA loans provide veterans with the ability to get a home loan with no minimum down payment and no PMI requirements. Many lenders across the country offer these loans, which are backed by the federal government’s Veterans Administration department. However, this program is only available to eligible veterans and their surviving spouses. If you’re eligible, this is likely your best option.
United States Department of Agriculture (USDA) loan
USDA loans are another zero-down mortgage option offered by private lenders but backed by the government. They’re available to applicants whose income does not exceed a given limit (which varies by state) and whose credit score is at least a 640. Further, the home in question must be located in an eligible rural area. While USDA loans don’t require PMI, they do require two forms of mortgage insurance, which are an equivalent expense.
Click here to learn the USDA’s income limits for your state.
Nowadays, you can find various conventional loans with low down payment requirements. The Fannie Mae-backed HomeReady mortgage is offered by most U.S. lenders and requires just 3% down. Further, it allows income pooling from all members of a household. That means that money from all of your family members can help you to qualify for a loan.
Another option is the Conventional 97 program by Fannie Mae and Freddie Mac. Again, only 3% down is required, and the money can consist entirely of gifted funds.
Some buyers choose to make their down payment by taking out a second loan, called a piggyback loan. Traditional piggyback loans cover 10% of the purchase price, requiring the buyer to come up with 10% for a down payment and to finance the remaining 80%. Other piggyback loans cover 5% for borrowers who make a down payment of 15%. Piggyback loans let you avoid PMI altogether.
Additionally, many state and local governments offer programs that may be able to assist you. For more information, check with your local housing authorities.
Do you need to make a 20 percent down payment?
Whether or not you should make a 20 percent down payment on your next home depends on your financial situation.
Typically, the more you put down, the lower the overall cost of buying the home. So if you can afford a 20% down payment, it will definitely cut costs. But if you don’t have the money, it’s not the end of the world.
Financing your down payment or settling for a smaller down payment will raise the total cost of your mortgage. Still, it’s better than endlessly paying rent, which builds zero equity. And there are many programs in place to help you take out a home loan with a down payment of around 5% or less.
Just be sure you shop around to find the best mortgage rates and lowest fees. If you aren’t sure where to start, review the industry-leading mortgage lenders below.
Jessica Walrack is a personal finance writer at SuperMoney, The Simple Dollar, Interest.com, Commonbond, Bankrate, NextAdvisor, Guardian, Personalloans.org and many others. She specializes in taking personal finance topics like loans, credit cards, and budgeting, and making them accessible and fun.