Conventional wisdom states everyone should aim to put a 20 percent down payment on a house. There are plenty of good reasons for paying at least 20 percent, but are there certain circumstances where paying less has benefits?
Why Paying 20 Percent Makes Sense
First, a 20 percent down payment makes sense because most banks charge higher interest rates on mortgages if you provide less than 20 percent. It’s not entirely difficult to find a mortgage where you only have to provide 5 percent or less for a down payment; however, keep in mind the bank is assuming more risk and will charge you more interest to justify this risk.
The second reason why paying 20 percent makes sense is you won’t have to pay private mortgage insurance (PMI). PMI exists for lower down payments because — once again — lenders view you as more risky. PMI can add anywhere from 0.15 percent to 2.5 percent to the initial mortgage interest rate, which can tack on a significant amount of money to your monthly mortgage bill. However once you reach 20 percent to 25% equity on your home you can ditch PMI.
The bottom line is that while a 20 percent down payment may seem like a lot of money, it can actually save you more money in the long run.
Reasons to Consider a Smaller Down Payment
For many people, the single biggest challenge to owning a home is affording the 20 percent down payment. However, closing costs also need to be factored in at the same time. Banks will often require you have a cash reserve left over on top of the down payment needed for a home, and between the cash reserve and additional closing fees, you may have to pay thousands more than the initial down payment. If the monthly payments won’t be an issue but the down payment is a stretch, consider looking into an FHA Loan. Unsure what an FHA loan is? Check out our straightforward review here.
If you do decide to make a smaller down payment, make sure you can really afford the property.
Another unorthodox strategy is to put down less and invest the difference. This makes sense if you’re a stock market whiz pulling in 20 percent to 30 percent annually, but the strategy might not be successful for the average homeowner.
Ultimately, it’s clear that a 20 percent down payment makes the most sense for home buying, but there may be situations where you decide to put down less.