Do You Really Need 20% Down?

Down payments are often a key factor in the minds of homebuyers. How much of a down payment will you actually need? How will the amount of your down payment impact your monthly payment and how much you can qualify for?

Let’s start by defining what the down payment is and why lenders generally want one. A down payment is the money that you bring to closing that gets applied directly to the purchase price of the home. It is not for the closing costs, taxes, or anything else.

Lenders view the down payment as a reduction of their risk in a few ways.  First, the more money you put down, the more equity there is in the home. Equity, to a lender, is a cushion for them to recoup their losses if you default on the loan.  Most mortgage defaults occur within the first couple of years, before the monthly mortgage payments and appreciation has the chance to build much equity, so having a strong equity position right from the beginning means less risk of losses for the lender.

Second, assuming the down payment is not coming from a gift, it provides a demonstrated ability to save; perhaps even a habit of saving and that is a characteristic that many mortgage underwriters love to see. Third, the down payment becomes your “skin in the game,” meaning you, like the lender, have a lot to lose, too.

Though the amount required varies, most mortgage programs require a down payment, but that requirement may not be the only consideration for how much money you put down.  The down payment impacts the maximum sales price you qualify for and it can affect your interest rate and mortgage payment, too.

Let’s say that the maximum loan amount for your comfortable payment is $250,000 and the loan program you are using requires a 3% down payment. That means, in rough numbers, you can pay up to about $258,000.  But what if the house you find is $265,000? Assuming you qualify, you have a choice to make.  You can either accept a higher monthly payment, raise your down payment to cover the difference, or a combination of both.

Also, lower down payments do tend to result in higher interest rates and mortgage insurance premiums which means less of the payment you qualify for goes toward your principal balance.  The result is the principal balance you qualify for is lower.  Keep in mind that this is not always the case and may be different for your specific situation.

As far as how much you have to put down to buy a home, the 20% myth just won’t go away. In the old days, before mortgage insurance and government guarantees, 20% was the rule for the reason noted above: banks wanted that equity cushion to prevent losses in the event of a default. But that hasn’t been the case in a long time. In fact, the average down payment for home purchases has been falling for decades and one of the most popular mortgage programs, FHA loans, require as little as 3.5% down. There are some programs that allow people to purchase a home with very little, or even no, cash out-of-pocket.

To learn more about what options are available to you, please do not hesitate to contact me at your convenience. Every situation is different and there many loan programs available. I can help you get the information you need to make an informed decision and achieve your goals.