HOW MUCH IS THE RIGHT DOWNPAYMENT TO PUT DOWN AND WHY
This is one of the most important financial decisions you’ll ever make. And let’s face it: homes are expensive, sometimes prohibitively so, especially in the current market. But there’s one common financial deterrent that potential homebuyers might be able to take off their list of barriers to entry in real estate: the 20% rule.
In years past, it was typical that 20% was the standard amount needed to put down when buying a new house. And many people looking to enter the housing market will still see this number as the expectation. They might even put off their plans to buy a home, or filter their options based on that assumption. Some even think that it’s a requirement.
But the 20% rule no longer has to limit your options. There are benefits to contributing a larger down payment toward a mortgage, but in some cases there are also advantages to lowering that number. What matters most is taking the route that suits your unique circumstances, rather than holding fast to a flat percentage without proper context.
WHERE THE 20% RULE CAME FROM
The idea that homebuyers should always shoot for a 20% down payment isn’t actually a rule of real estate. The number originally came from a minimum that certain mortgage programs set in relation to mortgage insurance. Meaning, conventional mortgages often require homebuyers to contribute a 20% down payment if they want to avoid paying private mortgage insurance (PMI) fees on top of their regular monthly mortgage payment.
But that doesn’t mean that 20% is a requirement. The true minimum on a conventional mortgage is often between 3% – 5%. Additionally, a conventional mortgage is only one option for a home loan. Other avenues include government loans through the Federal Housing Administration and Veterans Affairs, which offer minimums starting between 0% – 3.5% down. Individual credit scores factor into this equation to determine the exact number.
THE REALITY OF DOWN PAYMENTS
To say that the housing market and the economy have undergone significant changes since these numbers first became popular in real estate lingo would be an understatement. The housing boom of the early 2000s, and the Great Recession that followed around 2008, threw nearly everyone’s financial expectations and way of doing business for a loop, and mortgage regulations have gone from very loose to very tight.
And with a new generation of home buyers, it might not make sense for everyone to aim for 20% down these days, especially when the pursuit of such a high down payment delays a purchase. In some cases, just getting in the market is the most important thing. A second mortgage and other creative financing can be paid off and reconsolidated once you close on your new house and begin to see some appreciation.
THE BENEFITS OF A LARGER DOWN PAYMENT
There are certainly pros to putting 20%—or more—down on your home mortgage.
A higher down payment eliminates the extra cost of mortgage insurance (in the case of a conventional loan, as mentioned above), and lowers your monthly mortgage payment by reducing your principle. You’ll ultimately pay less for your home over time by putting more down now.
You’ll also get a head start on building equity. The more invested you are in your home right away, the more ownership you actually have on that property. If you’re not planning on staying in your home for a significant amount of time, or the value of your home drops unexpectedly between now and when you’re ready to sell again, more equity will help mitigate potential losses.
Furthermore, offering a higher down payment may help your offer stand out in competitive bidding situations. Sellers will appreciate the gesture of confidence and financial stability.
THE PERKS OF A SMALLER DOWN PAYMENT
A higher down payment might come with lower monthly costs, but a robust savings account is also important at the end of the day.
If hitting 20% means scraping the bottom of your bank account, think twice. Emergencies happen without warning that will leave you wishing you hadn’t put all of your free cash into the house, even though it’s still there in equity, think of it as a 30-year savings bond. That money is gone, for now. Additionally, having reserves in your bank account can also positively affect your financing.
Another consideration—if contributing a lower down payment gets you into the real estate market sooner rather than later (or at all), then it could be worth it to make the leap with less money on the table. If you’re able to stay in the home for a while, it will appreciate as you continue to pay off your mortgage. Additionally, if you are looking to fix-and-flip, sometimes 20% down isn’t necessary or doesn’t make the most financial sense.
Talk through your specific situation with your trusted Nest real estate agent, mortgage lender, and financial advisor. The right down payment is the amount that sets you up for success, today and into the future.
If you’re considering embarking on the home buying journey, check out this recent blog: Thinking of Buying a Home This Year