Do You Really Need That 20% Down Payment on a House?
If you're thinking about buying a house, there's a good chance that you're saving up the 20 percent down payment. Or perhaps you've given up on your dream of home ownership because you don't think you'll ever be able to amass that much to pay upfront for a house.
But do you really need a 20 percent down payment, or is this a myth? Turns out, there's more fiction to that "requirement" than fact.
"There are many people who are still under the impression, maybe from their parents, that a 20 percent down payment is needed to buy a house—but that's not the way it's done anymore," says Alex Elezaj, chief strategy officer and director at United Wholesale Mortgage in Pontiac, Mich.
So where did this figure come from, and why has the 20 percent down payment standard persisted?
"The traditional 20 percent down payment is designed, in large part, to protect the lender and the entire financial system," explains Aaron Dorn, chairman, president, and CEO of Studio Bank in Nashville, Tenn. "Having the 20 percent down payment invested into a property theoretically means that there is 20 percent equity in the property from the day the mortgage begins." In a worst-case scenario, Dorn says this equity can be recouped by the lender if the mortgage becomes insolvent and faces liens or foreclosure.
A survey by the National Association of Realtors reveals that 35 percent of consumers believe they need a down payment amount of 16 percent to 20 percent—and an additional 10 percent of consumers believe they'll need to put down more than 20 percent.
But, according to Elezaj, the average down payment is actually between 8 percent and 10 percent, but he says borrowers can put as little as 3 percent down on a home. "There are many mortgage down payment options under 20 percent, and borrowers can choose how much they are comfortable putting down, whether that's 3 percent, 5 percent, 10 percent down, whatever is best for them," he explains.
Private mortgage insurance
An alternative to 20 percent down is private mortgage insurance (PMI). "Lenders are concerned that a borrower does not have enough skin in the game when making the lesser down payment, so they will incorporate mortgage insurance, which protects the lender in case of default," says Sarah Alvarez, vice president at William Raveis Mortgage in New York City. "The mortgage insurance varies based on a number of factors, which are indicative of the ability to repay, including your credit score, the amount of financing you are taking, and the loan to value."
PMI is an insurance policy that the lender takes out to offset the risk that you may not pay the mortgage. "This insurance helps cover that potential default on the loan, and there are different ways to structure the payment of the PMI," says Esther Phillips, senior vice president of sales at Key Mortgage Services in Schaumburg, Ill.
For example, she says it can be paid monthly, upfront in a single payment, or there can be a split version of the two. "You could also potentially take out two loans to cover the total loan needed, such as one for 80 percent of the purchase price and then a second for the remainder." Phillips calls this a "piggyback" and says it avoids the PMI requirement.
Why some buyers may not want to put down 20 percent
Given a choice, some buyers may choose to put down 20 percent, but others may not. "Especially as rates remain historically low with a buoyant stock market, there are many people who want to take advantage of getting maximum financing to be able to put their assets to work elsewhere," explains Alvarez.
Also, she points out that buyers may want to hold on to those additional funds in case they need to make repairs or renovations to the property. "They may also want to make sure they have enough funds available in case an emergency comes up," Alvarez adds. "It is also possible that, for a myriad of reasons, someone may not want to liquidate a stock or retirement position, so while they are certainly capable of making the 20 percent down payment, it is not currently in their best interest due to tax or other consequences."
Phillips agrees that there may be several reasons why buyers may want to keep money in the bank or put down the least amount possible. But how would this impact the monthly mortgage—would the amount still be reasonable enough that it wouldn't pose a hardship?
"With rates as low as they are, a great way to have both an affordable payment and peace of mind is by adding $20 to $40 a month to the payment while keeping $5,000 tp $10,000 in the bank for emergencies," Phillips says.
Programs that provide down payment assistance
Keep in mind that not all mortgages are created equal, and the likelihood of finding one that suits your needs are extremely high. And according to Dorn, lenders look at the total picture to determine a buyer's ability to make payments.
"The down payment alone isn't a strong indicator of one's ability to pay the loan," he says. "More often, the greatest factors in determining loan eligibility are credit histories, income sources, and debt-to-income ratios."
And fortunately, there are several programs for buyers to choose from. "FHA loans are very popular, and they often require only 3.5 percent down, while USDA and HUD mortgages may not require any down payment at all," Dorn says.
And those aren't your only options. "VA loans are also available to those who have served our country in one of the military branches," explains Elezaj. "There are also conventional loan options that don't require 20 percent down."
And your local lenders may know of other opportunities. "At Studio Bank, we have invested in a down payment assistance program with a Nashville-based non-profit to help as many of our neighbors as possible realize the dream of home ownership," Dorn says. "There are a lot of options available—you just have to know where to look, or work with a local lender that can connect you with the resources in your area."