How much should you put down on a house? We looked at pros and cons of large and small down payments to help you make the best decision for your finances. —-
Buying a home is one of the biggest investments a person can make in their lifetime. In addition to making sure you meet all the lending requirements, getting your credit in order, and figuring out how much house you can afford, you’ll also need to save money for your down payment.
While a 20% down payment is often seen as the standard for home purchases, it can be a hefty chunk of change, especially for a first-time homebuyer. Saving up that much money takes time, and watching your slow-growing savings account can make you feel like you’ll never be able to afford a home. And with the likelihood that homes will only appreciate in value, it can also feel like you’re getting priced out of the market before you’ve even started.
Luckily, there are other options available to buyers, and you might be surprised to find that you can become a homeowner with a down payment of just 3% to 5%. In fact, there are valid reasons why it might be better to go for a lower down payment as opposed to making that 20% commitment.
HomeLight looked at the pros and cons of both larger and smaller down payments, interviewing real estate and mortgage professionals, as well as investigating statistics on just how much people are putting down on homes these days, all to help you decide what will work best for you when it comes time to make your home purchase.
One note: During riskier loan environments, such as during a recession, lenders will often protect themselves by increasing the standards required to get a mortgage loan. These increased standards are called mortgage overlays, and they may include bigger down payments, higher credit scores, lower debt-to-income ratios, or a combination of these changes.
Average down payments
According to data collected by EllieMae, a software company that processes more than 30 percent of the nation’s mortgage loans,2019 statistics show that the average down payment for FHA loans was 5%. Conventional loans were more likely to have a 20% down payment, and VA loans averaged just 2% down.
In regards to overall statistics, The National Association of Realtors 2019 Profile of Home Buyers and Sellers show stats that indicate first-time homebuyers made an average down payment of 6%, while repeat buyers put down 16%, for an average of 12% for all buyers. Of those buyers, 33% were first-time homebuyers, and 86% of all buyers financed their home purchase. First-time buyers financed approximately 94% of their home, while repeat buyers financed 84%.
Arizona real estate agent James Michener, a seven-year veteran of the industry, says that while 40% to 50% of buyers put 20% down, the rest are divided between a small percentage who pay cash and those who put down anywhere from 3% to 5%.
“It really depends on income levels and what that mortgage payment needs to look like,” he says. “Putting 20 percent down brings a guarantee of a lower payment, and of being able to afford your home forever. But sometimes putting less down can actually make more sense.”
When 20% is the way to go
If 20% down is feasible for you financially, you’ll have the benefit of that immediate equity in your home, as well as being exempt from having to pay mortgage insurance, which most lenders require of buyers unable to put down 20%.
Mortgage insurance (or MI, or PMI if you’re looking at private mortgage insurance) protects the lender against default and losses due to foreclosure if the borrower is unable to pay the mortgage. Depending on the specifics of your loan, it can add upwards of $2,000 a year to mortgage payments.
A larger down payment also means a lower monthly payment and lower interest rate, which can be a huge savings over the lifetime of the loan. If you’re trying to buy in a competitive market with multiple offers on homes, a 20% down payment can also look very attractive to sellers, as it gives them a stronger sense of your viability as a buyer.
April Wise, a mortgage underwriter and Associate Product Manager with HomeLight Home Loans, says that in her experience, homebuyers who put down 20% do so primarily to avoid mortgage insurance. “Buyers often don’t want to pay MI,” she says. “It does feel like wasted money to people. And for those who aren’t planning to owner-occupy a property, such as investors, 20% down is required no matter what.”
Wise adds that a lower loan-to-value ratio can affect not only interest rates, but also things like home insurance. “With a lower loan amount, you’re also more likely to have slightly less expensive home insurance.”
When less is more
Making a large down payment might be considered optimal, but it isn’t always realistic, and sometimes it isn’t even beneficial. “If the home is a fixer, in need of cosmetic or structural improvement, a buyer is better served to put less down so they can put that extra cash back into the property,” says Michener. “You don’t want to invest all your savings into the down payment and be left with no cash to reinvest into the property.”
Michener adds that first-time buyers often can’t afford to purchase a turnkey home, and by making a smaller down payment, they can use that extra money to make improvements, which in turn helps increase the value of their home.
“Unexpected repairs or expenses will always come up,” he says. As a real estate agent, he also makes sure to talk to his buyers about what they can afford and counsels them about not always reaching for the top of their budget. “If they cannot put 20% down, we want to make sure they aren’t going to end up with a payment that is too high,” he says.
Buyers who don’t have a 20% down payment, or don’t want to wipe out their cash reserves, can take advantage of loan programs that allow lower down payments, making it easier to become a homeowner and start building equity right away. “For conventional loans, you can put down as little as 5%,” says Wise. “And if you’re a first-time homebuyer, the minimum is just 3%.” Although those loans do require mortgage insurance, keep in mind that you can refinance the loan once you reach 20% equity, and you’ll be able to drop the PMI at that time.
Wise says there are some options aside from having to pay PMI if you can’t manage a 20% down payment. “There are some programs where you can structure a first and second mortgage,” she says. “There are also jumbo programs, in which you have a loan that exceeds the conforming loan limit, and if you put 10% down, you don’t have to pay PMI.”
Wise also points out that “first-time homebuyer” doesn’t necessarily mean someone who has never owned a home.
“In regards to the criteria for loan programs, a first-time homebuyer is someone who hasn’t bought or sold a home in the last three years,” she says. “Buyers should also always look into local community programs that are offered for first-time buyers, as they can vary from state to state.”
The best option for you as a buyer
When trying to decide how much of a down payment is best for you, talking to experts like your real estate agent or mortgage lender can help you determine what you can afford, what loan program to use, and exactly how much of a down payment to make.
“It’s all a bit of a balancing act,” says Wise. “And we have to look at what we call layered risk. If you’re maxing yourself out, using every dollar you have for the down payment and still have other debt, at that time it might be best to make a smaller down payment, or to wait and save a bit more.”
Michener says it’s important for buyers to really look at their income levels and understand what they can afford, and to get creative with their lender in regards to determining the optimum down payment and loan. Buyers should also keep in mind that changes in the market can affect their buying power, both positively and negatively.
“If we have another market crash, banks hold onto their money more and aren’t as willing to lend to people who have lower credit scores or lesser down payment,” he says. “Interest rates are likely to be higher, lenders aren’t going to give loans as freely.”
While saving and making sure you’re in a good financial position to buy is important, not having a 20% down payment doesn’t have to be a deal-breaker, and with a little help from seasoned professionals, you could become a homeowner sooner than you think. Rather than giving money to a landlord every month, you can own a home and start building equity in your investment right away.
“When you buy, you have security,” says Michener. “You aren’t at the mercy of a landlord and in the long run, it will only benefit you and your family.”
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