What You Might Be Misunderstanding About Down Payments

One of the main concerns about buying a home is just how large your down payment should be or what your home loan will entail. In reality, there’s no one correct answer, and this can certainly be confusing for first-time homebuyers.

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Standard wisdom for years has been that homebuyers should put down 20%, but that isn’t actually some type of industry mandate — it’s more a general metric for lenders and Realtors alike. Although some real estate experts may tell you that you need to put down 20% — and in many cases, that may be appropriate — it’s not as if you can’t legally buy a house unless you pony up that much cash.

However, when it comes to everything from saving money to closing costs, the question remains: How much do you actually need to put down on a house? Let’s explore.

While there are no “rules” for how much you need to save for a down payment on a home, there are minimums that certain loan types require. Individual lenders are free to request whatever down payment they wish for their mortgage loan program. Here are a few considerations:

If you qualify for a VA or USDA loan due to your affiliation with the military, you may be able to get a loan with 0% down.

FHA loans, which are generally extended to those with lower credit scores, can be acquired with a down payment as low as 3.5%.

Most conventional loans, including adjustable-rate loans, require at least 5% down, although some lenders may go down as low as 3% for a minimum down payment.

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The most common reason why 20% is often suggested for a down payment is that it allows you to avoid private mortgage insurance, commonly referred to as PMI. Private mortgage insurance helps protect lenders against default, as statistically speaking, a smaller down payment makes default more likely.

PMI will raise the cost of your mortgage by a significant amount, commonly 0.5% to 1.5% of your loan amount per year. On a $300,000 loan, this means your PMI will add somewhere between $125 to $375 per month to your mortgage payment.

Not only might that be enough to make a home unaffordable for you, but it’s also money that is essentially going right down the drain of your monthly payments. While your mortgage payment itself will actually help you build equity in your home, your PMI just lines the pocket of the insurance company and their potentially higher interest rates.

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Another reason many suggest that you put 20% down on a home is that it’s likely to prevent you from being “upside down” on your loan, or owing more than the home is worth. If you put down 5% and your home value falls 10%, for example, the value of your home will be less than the size of your mortgage. However, if you put down 20% instead, you’ll still have equity in your home, which is a much better long-term financial plan.

Although putting 20% down on a home is considered to be a conservative option, there are some potential drawbacks as well. The first is that it can take quite a long time to save enough for a 20% down payment. If you’re looking at a $400,000 home, for example, you’ll need to save $80,000 just for the down payment.

Depending on your income and saving habits, this could take years. If you only put 5% down instead, you’d only have to come up with $20,000. This could move you into a home sooner, getting you away from renting and potentially benefiting from home price appreciation years earlier.

Another drawback of putting up so much money is that it’s essentially “lost” to you. Although your down payment will become equity in your home, actually using that money is difficult. To draw it back out, you’ll either have to sell your home, take out some type of home equity loan or line of credit or pull cash out through refinancing.

All of these options take time, and some may reduce or damage the equity in your home. If you instead put a smaller amount of money down, you can use that excess money for other investments, such as the stock market, while still owning a home.

The first thing you should realize is that there is no “wrong” answer when it comes to how much you put down on your house. Each person’s financial situation and goals are different, so the decision you make should be the best for you — not some hypothetical homebuyer.

Ideally, if you can put down 20%, it’s the most conservative option and avoids PMI. But you don’t need to put down 20%, and in some cases, it may be better financially if you don’t. It’s always a good idea to consult with a financial advisor to help you determine the best options for you and your new home.

John Csiszar contributed to the reporting for this story.