Do I need to make a 20% down payment when I buy a house?
You may have heard from a parent or a friend that you need to be able to make a 20% down payment in order to buy a home. Is it true? Simply said, no it is not true, but if you don't put down 20% there are considerations.
Providing a 20% down payment on a home is called getting a 'conventional and conforming' loan, but for many, this can be difficult. Let’s say you have a home with a purchasing price of $600,000, that would be a $120,000 investment plus any closing costs. That is no chump change! Banks and lenders have created mortgage products in which you can provide as little as 5% of the purchase price. Also, if you qualify for an FHA loan or another government insured program, you can put down 3.5% or even less.
While the benefit of putting down less than 20% on the purchase of your home and saving money may seem like a no brainer, keep in mind, smaller down payments come with fees and risks to consider. Here’s what to consider:
Higher interest rates:
Very likely less than a 20% down payment will result in a higher interest rate. Remember, banks and lenders are investing with you when they provide you with a mortgage. They depend on your ability to pay them back over some time. More perceived risk results in higher interest rates. When you invest less on a down payment, you take on a larger loan; it results in larger monthly mortgage payments, which is riskier for a bank or lender. You could expect your rate to be ~0.5% higher than otherwise, depending on your down payment.
Keep in mind, multiple risk factors are considered when a bank or lender provides you an interest rate like your credit score, your employment, and your down payment amount.
Private Mortgage Insurance (PMI):
When you put down less than 20% on your home purchase, your bank or lender will charge you for PMI. Since they are taking an additional risk by loaning you more money, they charge a fee. Depending on how much you put down, your credit score, where the home is, the bank or lender you choose to work with, and the mortgage product you choose, your PMI payment on average can range $50-$500 per month in addition to your mortgage payment. This is calculated by multiplying the bank or lender's 'factor' or 'PMI premium' (which ranges between .55% to 2.25%) by the loan amount and divided by 12. This is paid until you reach a 20% downpayment with the bank or lender.
For example on a 30 yr fixed mortgage:
Purchase Price: $600,000
Loan Amount: $510,000; 85% loan to value (LTV)
Downpayment: $90,000; 15% down
PMI Premium: .65% (ranges .55%-2.25% depending on bank or lender)
Monthly PMI payment: (.0065 x $510,000) / 12 = $276.25
Make sure to ask your lender what their factor or PMI premium is.
Higher Overall Monthly Mortgage Payments:
It’s clear that putting less than 20% on a down payment results in higher monthly mortgage payments. A combination of higher rates, a larger loan, and PMI makes this the case.
The good news is that you have options with how much to put down on a home. The bad news is that with less than 20% there is a cost which is incurred. But it affords you the option of saving cash to perhaps invest elsewhere or save for something in the future. Does it make sense for you to put down more money, stretch yourself thin, and save on monthly mortgage payments? Or put down less and pay a higher monthly mortgage? It’s a calculation and personal decision you will want to consider. If you’re simply unable to afford a large down payment, just be sure your estimated monthly mortgage is something you can manage financially. Go ahead and use this calculator to estimate for yourself.
Feel free to reach out to us and get connected with our preferred lender to understand further about down payment options when assessing mortgage options.