Maybe you’ve heard the conventional wisdom about a down payment on a house: Aim for 20% of the home’s purchase price. But for a lot of people in a lot of markets, that’s a lot of money. Like a lot of money: The median home price in the United States is $218,000 — so we’re talking $43,600 for a 20% down payment. And in places like Manhattan, where the median home price is $1.3 million and change, you’re looking at price tag of over $250K.
You can buy a house with as little as 3.5% down with an FHA loan … so sticker shock may have you wondering whether putting a full 20% down is really all that important. It’s not impossible to get a mortgage with a smaller down payment, but 20% really is the gold standard for a reason. Actually, we can think of four reasons:
Putting down less than 20% is a legitimate risk
As the last recession drilled into our collective consciousness, home values don’t always go up. Sometimes they go down. Sometimes they go down a lot.
If your home’s value drops by more than the amount of your down payment, you’ll find yourself “underwater,” meaning that you’ll owe more than the house is worth. If you’ve put 20% down, it’s pretty unlikely that you’ll find yourself in this situation. But if you’ve only put 5% down, even a small decline in house prices could dunk you. (Just ask those people who wondered if 20% was necessary when they were buying homes in the early 2000s.)
Underwater is not a place you want to be. If something happens to your income and you can’t afford your house anymore, or if you want to move because you got a new job or decide your dream house isn’t so dreamy, you won’t be able to sell it without paying the difference (which, if you’re moving for financial reasons, is not likely to be feasible).
You’ll have to pay PMI if you put down less than 20%
Being underwater on your house isn’t bad just for you. It’s also bad for the lender who gave you your mortgage. That’s why they’ll make you pay private mortgage insurance (PMI) — also called lender’s mortgage insurance — if you put down less than 20%. It helps protect them.
PMI typically costs between 0.5% and 1.5% of your loan balance, depending on the size of your down payment and your credit score — and it isn’t always tax deductible. If you put 5% down on a $400,000 home (that’s $20,000 down, meaning your loan is for $380,000) and your PMI costs 1%, you’ll pay an extra $315 a month. As if your mortgage payments, property taxes, and maintenance costs weren’t expensive enough.
You can probably get a better house
When you have 20% to put down, you’re a more attractive buyer (because you’re a safer bet). Everyone from sellers to real estate agents and mortgage lenders will think you’re awesome. This often means better service and an increased likelihood that your offer will be accepted.
You could save money
When you put down a bigger initial payment, the amount you’re borrowing for your mortgage is smaller. That means you have less debt. That means your monthly payments are smaller. It also means you pay less interest over the life of the loan. (Actually, you’ll probably double-save on interest because you can usually get a lower mortgage rate if you put more money down. That whole attractive-buyer thing again.)
It’s true that instead of putting down the full 20%, you could invest some of it in the hopes of earning market returns. Don’t get us wrong — we’re all about investing, because the longer we wait to invest, the more it can cost us. But by putting down 20%, you’re certain to end up with a lower monthly payment on an equivalent mortgage — and “certain” is never a word you can use with market returns.
Thinking about saving for a down payment? Check out these four steps to take before buying a home. (Putting money away is only one of them.)