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Should You Go Beyond a 20% Down Payment?

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For many aspiring homebuyers, saving up enough money for a down payment on a house can feel like an impossible task. And even when they’ve reached their homeownership goal, they may feel like they missed the mark on the amount they decided to contribute toward their home purchase.

In fact, more than two-thirds of homeowners said they should’ve saved more down payment money, according to a recent survey conducted by Freedom Debt Relief.

But what if you’re on the other end of the spectrum and have more than enough money for the traditional 20% down? Is it better to put a large down payment on a house?

We’ll break down the pros and cons of going beyond a 20% down payment to help you decide whether that’s right for you.

The significance of a 20% down payment

Banks originally required a 20% down payment to minimize the risk of suffering a big financial loss if they needed to foreclose on borrowers who stopped making their mortgage payments.

A foreclosed home represented dollars the bank couldn’t lend to the community. Selling that home at a 20% discount generally allowed them to move it quickly, which is why the 20% down payment requirement carried weight.

A 20% down payment also lowers your loan-to-value (LTV) ratio, which is the percentage of the home’s value that is financed by the mortgage. Putting 20% down means you would be financing 80% of the home’s purchase price — giving you an 80% LTV ratio. A higher LTV means a smaller down payment and larger loan amount, which translates to more risk for the lender.

For example, if the home you’re looking to buy is $250,000 and you want to put down 20%, your down payment amount is $50,000, and the remaining $200,000 would be the amount you’re financing through the mortgage. Divide $200,000 by $250,000 to get an 80% LTV ratio.

The mortgage industry has changed over time, however. Fannie Mae and Freddie Mac — the two major mortgage agencies that receive backing from the federal government — routinely buy mortgages from lenders, reducing much of the risk that banks used to assume. And while making a 20% down payment used to be one of the only ways you could buy a house, there are now several programs that let you get in the homebuying game at a much lower cost.

Still, a 20% down payment has largely remained the standard, and there are plausible reasons to contribute this particular percentage to your home purchase — if you can comfortably afford to do so.

Benefits of a 20% down payment

  • Smaller monthly payment: A bigger down payment means a smaller loan amount, which leads to a smaller monthly mortgage payment.
  • No private mortgage insurance: Many lenders require you to pay for mortgage insurance if you put down less than 20%, which increases both the upfront and monthly cost of the mortgage. Mortgage insurance reduces the lender’s risk when providing loans to borrowers with smaller down payments. Conventional mortgage borrowers must pay private mortgage insurance if they put down less than 20%, while those with Federal Housing Administration (FHA) loans pay mortgage insurance premiums.
  • Lower interest rate: You might get a lower mortgage rate than a borrower with a smaller down payment. Lenders consider borrowers with a larger down payment less risky than small down payment borrowers.
  • Reduced closing costs: Certain closing costs, such as the lender origination fee, are tied to the amount of the loan. You can reduce these costs by putting more money down.
  • Compensates for a lower credit score: A larger down payment can make it easier for a lender to approve you for a loan if your credit score is on the lower end. As mentioned, more money from you means less risk for your mortgage lender.
  • Flexibility: If for some reason you need to sell your house quickly — due to a job transfer or job loss, for example — having equity in your home gives you more flexibility to potentially sell at a discount without having to bring additional cash to your closing.
  • Quicker path to debt freedom: You can pay off your mortgage much sooner if you make a 20% down payment. Your mortgage is smaller, your interest rate is likely lower and you avoid PMI. All these factors combined can help you get rid of your mortgage debt at a faster pace.

Downsides of a 20% down payment

  • Other savings are sacrificed: Some homebuyers think they must put 20% down and might empty their bank accounts to follow that rule. This leaves them without an emergency fund or other savings, which can cause future financial troubles.
  • Opportunity cost: With mortgage rates at all-time lows, and the potential to deduct that interest on your annual tax return (for mortgages worth up to $750,000 in most cases), you may be better off making a smaller down payment and investing the rest of those down payment funds elsewhere.
  • Lengthy timeline to save: It can be difficult to save up a large down payment. A 20% down payment on a home with a $200,000 sales price is $40,000. It could take years to save tens of thousands of dollars, which might make a large down payment an unreasonable goal.

Should I put more than 20% down on a house?

Although a 20% down payment would make your lender happy, when might it make sense to make an even larger down payment for your home purchase?

One scenario deals with interest rates. We’ve established that the more you put down, the better your chances are of getting a lower mortgage rate. Doug Crouse, a loan originator at UMB Bank in Kansas City, Mo., said he’s seen the best rates go to homebuyers with at least a 760 FICO Score and a 30% down payment.

A larger down payment could work for homebuyers who have significant savings but more modest income. By using that savings to put more money down, you can reduce your monthly payment and make things easier on your budget.

Benefits of a larger down payment

Many of the perks of a larger down payment are simply extensions of the reasons why 20% down seems sensible.

  • Lower closing costs
  • Less interest paid over the life of the loan
  • More flexibility to sell or borrow on short notice
  • You can potentially buy a bigger home if you are willing to make a larger down payment
  • You have the capacity to be debt-free even sooner

To summarize, the main benefits of a larger down payment are short-term savings in the form of smaller monthly payments, and long-term savings in the form of reduced interest costs over the loan term.

Drawbacks of a larger down payment

Making a larger down payment can make sense and save you money, but there are a few downsides to consider.

The biggest consideration is how the down payment will affect your other financial needs. Once you’ve put money into your home, the only way to get to your money is to refinance, sell your home or borrow against your equity through a home equity loan or home equity line of credit. Life has emergencies, and it’s very important to budget for home repairs and have an emergency fund before making a large down payment.

Crouse said opportunity cost is another potential downside to making a larger down payment, especially if you can secure a low interest rate and you’re able to itemize deductions, which reduces the cost of your interest payments. In that case, he argues that you might be able to earn a higher return elsewhere, either by investing the money or by paying off higher interest rate debt, such as credit cards or student loans.

In other words, your mortgage should never be viewed in a vacuum. It’s important to evaluate any decision within the context of your overall financial situation.

Why put down less than 20%?

A down payment of 20% or more doesn’t work for every homebuyer. Fortunately, there are a number of mortgage programs available that allow you to buy a house with less money down. It may be worth exploring these options to help you decide on the right down payment percentage.

With that in mind, here are a few programs that can either help you afford a larger down payment or allow you to put less than 20% down.

Mortgage options for smaller down payments

Loan Type Down Payment Requirement Mortgage Insurance?
FHA  3.5% or 10%

(depending on credit score)

Required for life of loan

(in most cases)

HomeReady®  3% Required until LTV reaches 80%
Home Possible®  3% Required until LTV reaches 80%
SoFi  10% Required until LTV reaches 80%

FHA loans

FHA loans are backed by the FHA, which is an arm of the U.S. Department of Housing and Urban Development. The federal government guarantees it will pay the bank for the loan if you stop making mortgage payments.

In return for that guarantee, banks are willing to provide mortgages with lower down payments and looser credit requirements. People with a credit score of 580 or higher can borrow an FHA loan with just 3.5% down, while people with a credit score between 500 and 579 are required to put at least 10% down.

The downside to this loan program is mortgage insurance. There’s an upfront mortgage insurance premium of 1.75% of the loan amount, and an annual premium that is added to your mortgage payment and paid monthly. The cost of the annual premium depends on your down payment amount, loan amount and loan term. You pay mortgage insurance for the life of your loan unless you put down 10% at closing or refinance.

Still, if your credit is less than perfect and you don’t have 20% or more to put down, an FHA loan can be a viable option.

Fannie Mae HomeReady

Fannie Mae’s HomeReady mortgage is specifically designed to help people with relatively low incomes.

In general, your annual income must be at or below 80% of the median income for your area, which you can look up. From there, you can qualify with a credit score of at least 620, or by going through a special underwriting process if you don’t have enough of a credit history to have a score.

If eligible, you can get a mortgage with as little as 3% down. Private mortgage insurance is required. Unlike with FHA loans, it’s removed once your LTV ratio reaches 80%.

Freddie Mac Home Possible

Freddie Mac’s low down payment option, Home Possible, only requires 3% down, and borrowers who don’t have a credit score may be able to qualify.

If you’re buying in a low-income census tract, there’s no income limit. Otherwise, your annual income must be equal to or below 80% of the median income for your area. Use Freddie’s income and property eligibility tool to verify whether you’d qualify.

You’ll also pay for private mortgage insurance until your LTV ratio reaches 80%.

SoFi

Homebuyers can get a SoFi mortgage worth up to $3 million with as little as 10% down. PMI is required for borrowers with a LTV ratio higher than 80%.

SoFi offers fixed- and adjustable-rate mortgages with 15- and 30-year terms, but you typically need good credit to secure a loan.

Zero-down mortgage options

Loan type Down payment requirement Mortgage insurance/Other fees
USDA  0% Up to 3.5% upfront guarantee fee; up to 0.5% annual fee
VA  0% 1.25%-2.4% upfront funding fee
Physician  As low as 0% (depending on home price) None

USDA loans

USDA loans are backed by the U.S. Department of Agriculture and available to people with low to moderate incomes who live in eligible rural areas. Most lenders underwriting USDA loans require a minimum 640 credit score with no significant delinquencies, foreclosures or bankruptcies in the past several years.

If you meet the requirements, you can get a mortgage with 0% down, as long as your non-retirement assets don’t exceed $15,000. While there’s no mortgage insurance, there is an upfront funding fee of no more than 3.5% of your loan amount and an annual fee of no more than 0.5% of your loan amount.

VA loans

VA loans are backed by the Department of Veterans Affairs and allow eligible service members, veterans and their families to purchase homes with 0% down as long as they have “satisfactory credit,” which may be a minimum 620 credit score, depending on the lender.

Another benefit is there’s no mortgage insurance, though there is a one-time funding fee that ranges from 1.25% to 2.4% of the loan amount, as of the date of publishing.

Physician loans

People in the medical profession can get a physician mortgage loan with as little as 0% down (although down payments of 5-10% appear to be more common) and no mortgage insurance requirement.

This can be helpful for medical professionals who are just starting out and aren’t earning much now but expect their income to increase significantly in the future. It can also be helpful for people already several years into the profession who would prefer to put their money elsewhere.

“A lot of doctors would rather have 100% financing and use the money to pay off student loans instead,” Crouse said. “It represents a better return on investment.”

The bottom line

The decision to make a larger down payment comes with trade-offs. On the one hand, a larger down payment reduces the overall cost of your mortgage and can remove certain fees altogether, such as PMI.

On the other hand, a smaller down payment can leave more money to meet other financial goals, such as boosting your emergency fund. Additionally, there are several programs that can help you make a smaller down payment without incurring too many extra costs.

It’s important to be aware of your options, but you still have to make an informed decision based on your financial circumstances. If you’re losing sleep at night because of the down payment percentage you’re considering, it’s probably not worth the trouble. Be sure to make a choice you’ll be comfortable with in the end.

 

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