Do you need 20 percent down to buy a house?

A realtor shows a kitchen to a couple.
September 17, 2019 | Katie Pins

You’ve decided you want to buy a house in the near future. It’s a big financial goal, and you’ll want to know how much you need to save for a down payment. Most of us have heard of the 20% down rule. For example, if you are looking to purchase a $450,000 home, you would put down $90,000 to reach the 20 percent threshold.

So, do you need 20% down to buy a house? Traditional mortgage lenders used to require 20% down, but now there are many options. Why are there more options? It can be difficult to reach that 20% goal depending on your timeline and your financial situation. Plus, your 20% down payment does not include closing costs, which is another expense to save for.

Buying a house with less than 20% down can broaden your choices, but it’s important to weigh the pros and cons to decide if it’s the right decision for you. We break down the different factors you’ll need to consider, including closing costs, rates and monthly payments, private mortgage insurance (PMI), and equity vs. liquidity.

Closing costs

There are pros and cons to putting less than 20% down when it comes to closing costs. Pro: you could have more money for some surprisingly steep closing costs. Many home buyers will save for the down payment and will forget about closing costs. The ability to put less money down on your home purchase may come in handy if closing costs are higher than you expected.

The downside is that some closing costs, such as the origination fee, are based on the size of your loan. Your mortgage will be higher the less you put down. So, closing costs are going to be higher with a lower percentage down.

Rates and monthly payments

When determining your rate, lenders take a look at several factors, including the type of mortgage (fixed or adjustable), your credit score, the size of the loan and the size of your down payment. Usually, a lower percent down means a higher rate. A low down payment is seen as riskier than a 20% down payment to the lender. To make up for that risk, they will require a higher rate from you.

In the long term, the higher rate could make a difference. Let’s look at an example. We’ll continue to look at a $450,000 home. If you put down 5% instead of 20%, the lender might tell you the rate is 0.25% higher. This would mean you have to pay an extra $69 per month in interest over 30 years.  (You can use a mortgage loan calculator to see how your payments may change based on your rate.)

As you can see, your monthly payments could be higher if you put less down initially. However, even though you have a higher rate now, you may be able to refinance your mortgage for a better rate after building some equity.

Speaking of equity, although you have a higher rate, you have a home that is building equity vs. waiting to purchase a home. Again, weigh the pros and cons to decide what down payment amount is right for you.

Private Mortgage Insurance

Private mortgage insurance or PMI is a type of mortgage insurance that protects the lender if you stop making payments on your home loan. It is a way to make sure the lender will get paid if you default on your loan or if you cannot make your monthly payments. PMI creates less risk for the lender. It’s required by some (but not all) mortgage lenders if you don’t put down 20%.

If you have PMI, you need to make insurance payments until you have paid 22% of the purchase price of your home.

You could avoid private mortgage insurance if your lender has a program such as the Alliant Advantage Mortgage (AAM) program. You can also avoid PMI by putting more than 20% down on your home purchase.

It’s important to talk to different lenders to see how you can avoid making those payments. If you are with a lender who can work around private mortgage insurance, then putting less than 20% down is an easier decision.

Equity vs. liquidity

Your down payment shouldn’t drain your bank account. You need liquid funds for those what-if moments. If you pour every dime into the down payment of your home and the basement floods two months later, how will you pay for that expense? Before committing to a down payment amount, consider your savings and how much you are comfortable with keeping in an account.

The amount you put down is a balancing act. You also want to put as much equity into your home as you can because it could lower your monthly payments and your rate. The more equity you have in your home, the more options you have to refinance. Decide which is more important to you when determining your down payment.

Options if you want to put down less than 20%

When shopping for a home, don’t forget to shop for a mortgage! Traditional mortgages can create roadblocks to buying a home. However, there are many programs that can make homeownership a reality without PMI or a large down payment. There are even programs that let you put 0% down without PMI.

It’s important to do your research and know your options. A conversation with a mortgage lender can be a helpful first step if you’re still unsure.

Katie Pins is a marketer fascinated with finance. Whether the topic is about the psychology of money, investment strategies or simply how to spend better, Katie enjoys diving in and sharing all the details with family, friends and Money Mentor readers. Money management needs to be simplified and Katie hopes she accomplishes that for our readers. The saying goes, "Knowledge is Power", and she hopes you feel empowered after reading Money Mentor.

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