Is 20 Percent the Best Amount for a Down Payment?
If you’ve been thinking about buying a home, you’ve probably been told that a 20 percent down payment is the gold standard for getting a mortgage. While it’s true that there are a lot of advantages to having this much money - and those who are purchasing a home with a $1 million+ price tag have to have at least 20 percent - you don’t need to have this much money to buy a home. In fact, there are some times when paying this much money is a disadvantage.
Learn more about this complex issue so you can decide which is the right decision for you.
Eliminating Mortgage Insurance
The reason why people talk about the 20 percent figure is that this is the threshold where you no longer have to pay mortgage insurance. This is an insurance fee that the bank will make you pay in case you default on the loan. It allows them to recoup their losses in cases like this. Once you have 20 percent equity in the home, the bank’s risk is significantly reduced, so this insurance doesn’t come into play.
However, the amount you’ll pay in mortgage insurance is usually a drop in the bucket compared to the other costs in the mortgage. It could be only $100 or less, depending on the amount of your mortgage. Some people feel like the savings you’d get from eliminating this payment is not worth the effort it might take to get that 20 percent down payment.
Big Sacrifices
For many people, saving up the 20 percent down payment means making big sacrifices. If you’re thinking about a $400,000 home, you’ll need $80,000 in cash for that down payment. This could mean missing out on vacations, cutting back on entertainment costs, and even carefully planning meals based on grocery store sales rather than what you want to be eating. Often, people make these sacrifices for several years before they’re finally able to save up enough money. You have to ask yourself whether or not you think it’s worth it to make these sacrifices.
Making Monthly Payments More Affordable
Of course, having 20 percent for the down payment of your home means that you’ll be taking out a much smaller mortgage. And with a smaller mortgage, you’ll have lower monthly payments.
Let’s look at some numbers to get a better idea of what this means. Let’s say you’re thinking about that $400,000 home, and you qualify for a 25-year mortgage at 4.5 percent interest. If you had a 20 percent down payment, your mortgage would be for $320,000, and your monthly payment would be about $1,780. If you only had the minimum down payment amount - 5 percent - you’d be taking out a mortgage for $380,000, and your monthly payment would be about $2,112. That’s a pretty big difference each month, and you also end up spending tens of thousands of dollars more in interest.
Waiting to Buy
Another thing you want to think about is how much longer it will take you to save up the extra money you need to get to 20 percent. If it’s going to take an extra two or three years, you may end up dealing with higher home prices and wishing you had bought earlier. Waiting a few years to buy also means that you’re missing out on building up equity. These are some good reasons to purchase the home with less than 20 percent as a down payment.
More Equity vs. Access to Liquid Funds
When you make a big down payment, you’re starting out with a lot of equity in your home. That’s a great move for some people. For others, though, it means that you’re tying up money in something that’s difficult to access. Sure, you can usually qualify for a home equity line of credit, but that’s harder -- and more expensive -- than just getting the money out of your bank account. If paying the 20 percent down payment completely depletes your savings account, it may be smarter to pay less. You want to have some cash on hand for emergencies.
When deciding whether or not to put 20 percent down on a home, the smartest thing to do is to think about how hard it is for you to get that money and how much money you’ll have after making that payment. Someone buying their first home is probably going to have to work hard and make some sacrifices to save up a 20 percent down payment. After buying the home, there might not be much left over.
In this case, you may want to pay less than 20 percent. However, if you are upgrading or downsizing a current home and you have a lot of equity, it’s probably easier for you to have enough money to reach that 20 percent. In this case, putting as much money as you can into the down payment is usually the best move.
