Do You Need 20% Down to Buy a House?

April 10, 2017 1 Comment »
Do You Need 20% Down to Buy a House?

It’s been some time since I’ve done mortgage Q&A, so without further delay, let’s explore the following question: “Do you need 20% down to buy a house?”

If you chat with anyone older than 50 (maybe 60), they’ll probably tell you that you need to (or should) put 20% down if you want to buy a house.

It’s conventional wisdom when it comes to home buying, but it’s not necessarily the reality anymore. In fact, the average down payment in 2016 was just 11%, per the National Association of Realtors (NAR).

But a lot of people still seem to think you need 20% down. The NAR 2017 Aspiring Home Buyers Profile report found that 39% of non-owners believed they needed more than 20% for a down payment on a home purchase.

And 26% believed they needed to put down 15-20%, while 22% said they needed a down payment of 10-14% in order to buy.

None of those answers are true.

20% Down Payments Used to Be the Norm

It was customary back in the day to come in with 20% down (or more) when purchasing a property. But times changed as prices rose and lenders got more competitive (and less risk-averse).

Leading up to the crisis seen in the mid-2000s, zero down was a common theme. In fact, there were lenders that named themselves after that lack of a down payment…

Of course, we all know what happened next – home prices tanked and low down payment options began to evaporate. That led to increased FHA lending, which requires only 3.5% down.

And over time, Fannie Mae and Freddie Mac introduced a competing product that allowed for loan-to-value ratios (LTVs) as high as 97% (3% down).

So we’ve kind of come full circle, though we’re not quite at the zero-down stage just yet. Keep in mind that many lenders offer mortgages with just 1% down, such as Quicken, Guaranteed Rate, and United Wholesale Mortgage.

Should You Put Less Than 20% Down on a Home?

We’ve already answered the original question. You don’t need a 20% down payment to purchase a home. In fact, you don’t need any down payment in some cases if you consider the VA or USDA.

You also don’t need to put down 10% or even 5% thanks to widely available programs from the FHA and Fannie and Freddie. But should you come in with less than 20%?

This answer is a bit more elusive because it depends on a variety of factors, which include your household balance sheet and your financial goals.

In short, the less you put down on a home, the more you pay each month via your mortgage payment. This happens for three main reasons:

– Larger loan amount
– Higher mortgage rate
– Mortgage insurance (added cost)

If you put down less than 20%, you wind up with a bigger loan amount (obviously), a higher mortgage rate (usually) because of pricing adjustments, and you have to pay mortgage insurance to protect the lender.

This means your monthly housing costs go up, but you keep more cash in-hand, or at least not in your house.

Let’s assume the home you want to purchase is selling for $350,000 and you plan to take out a 30-year fixed mortgage. This comparison chart shows us how things might look.

3% Down vs. 20% Down: The Math

$350,000 Home Purchase 3% down payment 20% down payment
Down payment $10,500 $70,000
Loan amount $339,500 $280,000
Mortgage rate 4.125% 3.875%
Monthly P&I payment $1,645.39 $1,316.66
PMI $125 n/a
Total monthly cost $1,770.39 $1,316.66
Difference +453.73

As you can see from the chart above, the 3% down mortgage payment is roughly $454 more expensive each month thanks to those three things I mentioned.

That higher payment equates to an additional $27,223.80 spent over the course of five years.

Additionally, because the loan balance and mortgage rate are higher, more of your payment goes toward interest every month.

After 60 months, the 3% down mortgage would have a balance of $307,684.69, whereas the 20% down mortgage would be whittled down to $252,738.50.

The tradeoff is basically more money in your pocket versus the home, and the ability to buy more house now in exchange for a higher monthly payment, assuming you lack the down payment funds and can afford the higher payments.

At the same time, I’ve argued that it’s possible to buy more house if you put more money down because less income is required. This assumes income is the problem and not assets.

Of course, it’s entirely possible for a low-down payment to be voluntary, for a homeowner who wants to park their money elsewhere.

That decision really comes down to how you value your investment, and if you think you can do better putting the money elsewhere.

For those who don’t have that choice, take comfort in the fact that you don’t need a 20% down payment to buy a home, or anywhere close to it.

But you will pay extra for that convenience, and you might have more hurdles to clear, such as convincing a seller to take your offer over another where the prospective buyer offers to put down 20%.

Alternatively, you could get a gift for a portion of the down payment and get the best of both worlds.

Pros of Putting Down 20% on a Home Purchase

– Lower loan amount
– No mortgage insurance
– Lower mortgage rate
– Pay less interest
– Ability to tap equity or take out a HELOC
– Lower closing costs
– Better chance of getting your offer accepted
– More loan options

Cons of Putting Down 20% on a Home Purchase

– Requires a lot more money up front
– May make you house poor (little leftover for repairs/maintenance)
– Money tied up in the home that could lose value (and thus access to it)
– Could invest money elsewhere for a better return
– Inflation makes money worth less over time

One Comment

  1. Phyllis Espinoza April 26, 2017 at 5:48 pm -

    Hi Colin, great article – you make some very good points. Bigger is still better.
    I wanted to mention that we work in the secondary mortgage market with people who don’t qualify conventionally, and we can offer note sellers top dollar on residential notes with as little as 10% down. We offer flexible note structures and flexible payout plans.
    I will follow you on Twitter.

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