down payment on home loan

Should you Make a 20% Down Payment?

Do you think you need a 20% down payment to buy a home? You aren’t alone – most people think this, but it’s not true. You can buy a home with as little as 3 – 5% down depending on the loan program.

So why the 20% down payment ‘ritual’ and should you consider it? Let’s look at your options.

Why you Should Make a 20% Down Payment

There’s one reason to make a 20% down payment – to avoid Private Mortgage Insurance. If you have 20% to put down on a home, you invest heavily in the home and reduce the risk of default. You increase your chances of securing conventional financing and never paying mortgage insurance.

This is a great reason to consider a 20% down payment. You’ll build equity in your home much faster and have an easier time qualifying for a loan.

Why you Shouldn’t Make a 20% Down Payment

There are plenty of reasons you shouldn’t make a 20% down payment. Here’s what you should consider:

  • You can’t get it back easily – If you invest all the money you have saved into your home, you have no reserves. The money remains tied up in your home. The only way to get it out is to sell the home or refinance, neither of which happen overnight or are guaranteed.
  • You have an opportunity cost – If you put all your ‘eggs in one basket’ you can’t invest elsewhere. What happens if real estate values drop? You lose money. If you have money invested in other areas, though, you offset the loss. When you put all your money into your home, you give up the opportunities to invest anywhere else.
  • You won’t have reserves – Life is unpredictable. What would happen if you lost your job, fell ill, or needed money for other reasons? If you give up all your savings, you won’t have anything to fall back on. This makes homeownership more stressful and even puts you at risk of losing your home if you can’t make your payments.

What are your Options?

Today you have plenty of options for various down payments. Choose the one that works best for your financial situation.

  • Conventional loans – First-time homebuyers need 3% down and subsequent homebuyers need 5% down. You’ll pay Private Mortgage Insurance until you owe less than 80% of the home’s value, but it’s temporary and if you have peace of mind knowing you have reserves, it’s often worth it.
  • FHA loans – All FHA borrowers with a 580+ credit score need just 3.5% down on a home. Borrowers with a 500 – 579 credit score need 10% down. FHA borrowers pay mortgage insurance for the life of the loan so there’s no benefit to making a larger down payment. You may be better off saving money for a rainy day.
  • USDA and VA loans – If you are eligible for either program (low income rural homebuyers or veterans), you won’t need a down payment as both programs offer 100% financing.

Bottom Line

Weigh your options carefully when deciding how much to put down on a home. A 20% down payment isn’t required and may hurt you financially if you don’t have other money available as reserves. Look at all your loan options and choose the one that makes sense not only today but in the future too.

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