By Mike Faden | American Express Credit Intel Freelance Contributor
7 Min Read | July 31, 2020 in Money
Many people believe you need a 20% down payment on a house, but some lenders offer mortgages with down payments as low as 3% or even zero.
The median down payment in 2019 was 6% for first-time home buyers and 16% for repeat buyers.
A bigger down payment means smaller monthly payments once you own your home, but a smaller down payment may help you buy a house sooner.
If you’re like most people, you’ll need a mortgage loan to buy a house. But while the loan covers most of the cost, your lender will also generally require you to pay a percentage of the purchase price as a down payment.
How much of a down payment do you need? Maybe not as much as you think. The traditional rule of thumb was that you need a 20% down payment to buy a house – and many potential homebuyers still believe that’s the case.1 But that belief doesn’t reflect reality. In 2019, the median down payment was just 6% for first-time home buyers, and 16% for repeat buyers, according to the National Association of Realtors.2 Multiple lenders offer mortgages with down payments as low as 3%, and some even offer zero down payment mortgages.3
The size of a down payment makes a big difference in how much cash you’ll need before you can buy a house. To buy a $300,000 house with a 20% down payment, you’d need $60,000, plus money for other expenses such as closing costs. For a 3% down payment, you’d need $9,000 plus closing costs. Still, a bigger down payment has its advantages. The size of the down payment may affect:
Here are some of the benefits of making a big down payment – and some of the reasons for considering a smaller one.
Making a big down payment has several advantages, especially if you’re able to come up with 20% of the home’s purchasing price.
No mortgage insurance. If you make a down payment of at least 20%, you generally don’t need to pay mortgage insurance. If your down payment is lower than that, you’ll probably need to add regular mortgage insurance premiums to your home ownership budget. Mortgage insurance protects lenders against the risk that you won’t pay back the loan. The lower your down payment, the bigger the lender’s risk. Mortgage insurance can add significantly to the monthly cost of owning your house: you could have to pay an annual premium of 0.5% to 1% of the loan amount. On a $300,000 house, that could translate into roughly an extra $125–$250 per month.4
Lower monthly mortgage payments. If you make a bigger down payment, you need a smaller loan, which means your monthly mortgage payments will be smaller and you’ll pay less for your house over the life of the mortgage. If you buy a $300,000 house with a 30-year mortgage at a 4% interest rate, and you make a 5% down payment, you end up paying $1,851 for principal and interest in your monthly mortgage payment. On the other hand, if you make a 20% down payment on the same house, your monthly mortgage payment will be $1,636. You’d be paying $215 less in monthly mortgage payments and $32,000 less, overall, if you continue paying the mortgage for the full 30 years. Plus, you’re not likely to need mortgage insurance with a 20% down payment.
Lower interest rates and more choice of loans. If you’re able to make a bigger down payment, you may get a lower interest rate, since lenders generally think a bigger down payment means less risk.5 A lower interest rate translates into lower monthly mortgage payments. You also may be able to shop for loans from a wider choice of lenders.
More equity in your home. A big down payment means you have more home equity right from the start. Home equity is the portion of your home that you truly “own”: your home’s value minus your mortgage debt. If you make a 20% down payment on a $300,000 home and borrow the rest, your initial home equity is 20%, or $60,000. There are several advantages of having more equity. It may be easier to refinance your mortgage or get a home equity line of credit if you need cash in the future. If you decide you want to trade up to a more-expensive home in a few years, you won’t need to borrow as much because you’ll be able to use the equity in your existing home as a down payment. And if the value of your house falls and you want to sell, there’s a better chance that you can walk away without owing money. A serious drop in house prices may seem an unlikely scenario today, but it happened in many areas in 2006–2009 and was part of what led to the last recession.
While a bigger down payment can mean your house costs less over the long run, a smaller down payment has plenty of advantages too: you may be able to buy a house sooner, and you won’t tie up so much of your cash in your home.
Faster route to home ownership. A smaller down payment may help you get into home ownership faster and more easily, because you don’t need to save as much before you can buy a house. If homes continue to rise in value, buying sooner also may mean paying a lower home purchase price than if you wait. And if you’re currently renting your home, the sooner you can buy the sooner you’ll be able to stop paying rent.
More cash for other homebuyer’s expenses. A smaller down payment leaves you more cash for other home-related expenses that you incur either when you buy your home or after you move in. For example, when you buy your home, you’ll generally have to pay closing costs that may total 2% to 5% of the home’s total purchase price. A smaller down payment also leaves you more cash for the ongoing expenses of homeownership, including any necessary repairs and renovations that spruce up your home (see “Budgeting Tips for New Homeowners”).
More cash for other purposes. With less of your money locked up in your home, you’ll have more for emergencies or other non-home expenses. Some experts suggest you should maintain a big enough emergency fund in cash to cover three to six months’ living expenses in case you encounter unforeseen problems, such as losing your job.6 And although buying a home is important, you probably also have other financial priorities. Choosing a smaller down payment may mean you have more money to put into your savings account or your kids’ college funds.
Rising home prices can mean you need more money for a down payment, because the down payment is generally a percentage of the home’s purchase price. To overcome that hurdle, one third of first-time buyers got help with the down payment from their family or friends in 2019, according to the National Association of Realtors7 There may also be other sources of money if you need help coming up with the down payment. In many states, there are assistance programs from government agencies, non-profits, and even employers that provide grants or zero-interest loans towards down payments. Other options may include personal loans.
It may pay to thoroughly research your lending options, since a wide variety of loans with different down payment requirements are now available from different lenders. For example, some mortgages are available via government programs that require low or even zero down payments.8 In 2019, 25% of first-time buyers purchased their home with loans backed by the Federal Housing Authority, which requires down payments as low as 3.5%.9 Some banks and commercial lenders now offer mortgages with 3% down payments, and some credit unions offer zero down payment mortgages.
When buying a house, you may have a choice of how big a down payment to make. Lenders now offer mortgages with down payments ranging from 20% or more to as low as 3%, and some even offer zero down payment mortgages. A bigger down payment can lower your monthly costs and the amount you pay for the house over time, while a smaller down payment may help you buy a house sooner and leave you more cash for other purposes.
1 “Reach Your Dreams with 3% Down,” Freddie Mac
2 “Families Using Creativity When Buying, Selling Homes: 2019 Buyer and Seller Survey,” National Association of Realtors
3 “How to Get a Mortgage With No Down Payment,” U.S. News & World Report
4 “PMI: A Guide To Private Mortgage Insurance,” Rocket Mortgage
5 “Do you need to put 20 percent down on a house,” HSH.com
7 “Families Using Creativity When Buying, Selling Homes: 2019 Buyer and Seller Survey,” National Association of Realtors
8 “Mortgage Lenders,” U.S. News & World Report
9 “Families Using Creativity When Buying, Selling Homes: 2019 Buyer and Seller Survey,” National Association of Realtors