Buying a home: The down payment myth

By Lisa Rinkus | Citizens Staff

A 20% down payment on a new home has always been the standard guideline. But it’s a huge amount of money for a first-time homeowner to come up with. It’s particularly daunting if you’re looking to buy in expensive markets like Boston or San Francisco.

But even though home prices continue to climb in several locations around the country, the average down payment for first-time homebuyers is just 6%, according to the National Association of Realtors. Some even put down as little as 3%, depending on their loan type and credit score.

The 20% down payment is common in real estate parlance because this is the amount homebuyers need to come up with to avoid mortgage insurance (MI). The cost of MI is typically anywhere from 0.2% to 1.5% of the total loan amount. Say, on the low end, your MI was 0.5% on your $200,000 loan. That means you would need to pay an extra $1,000 per year, on top of your mortgage payment. 

MI concerns aside, there are no right or wrong answers when it comes to how much you should put down on a home, according to the U.S. Consumer Protection Bureau. Depending on where you are on your financial journey, you have the power to control the process. 

Here’s what you need to know to determine whether a higher or lower down payment makes sense for you: 

• A lower down payment could mean you’re able to buy a home months (or years) earlier. Saving up 20% of the purchase price of a home —at today’s high prices — can take a long time for many of us.
• If you spend less on the down payment, you’ll free up funds to cover the myriad of other transaction-related expenses. These include inspections and closing costs.
• Once you move in, you’ll most likely need money for repairs, improvements, furniture, and maintenance. (Haven’t had a yard before? You’ll probably need a lawn mower.) And of course, it’s always a good idea to put aside any extra money toward an emergency fund. 

• If your down payment is lower, your monthly mortgage will be higher. It’s simply a matter of math — the smaller the down payment, the larger the amount left over to divide into monthly mortgage payments. You’ll also be paying more interest over the life of the loan, which could add hundreds of thousands of dollars to the original price tag.
• You’ll probably pay a higher interest rate with a lower down payment since lenders assume more risk. You will also be required to pay mortgage insurance. Known as MI, this offers the lender some protection against loss in the event you default on the loan. (The good news? You can cancel the MI once you reach 20% equity in your home.)
• You could end up with negative equity. In other words, if real estate prices drop, and because you didn’t put a lot of money down, your house is worth less than what you owe on it. This is known as being “underwater,” which can hurt your chances of qualifying for a home loan down the road.  (Unfortunately, being underwater can occur no matter how much you put down for a down payment.)  And not being able to sell your home for at least what you owe is a huge risk that could set you back significantly.

If you don’t have 20% saved for a down payment, you don’t have to give up on your dream of buying a home. However, your current financial situation and future goals will play a big part in determining what kind of payment is right for you. For example, do you have an emergency fund? How much debt do you have? How close are you to retirement? Are you planning a family? These will all factor into your decision. The amount you choose to put down on a home is different for everyone.

If you feel ready to make a move, we can help. Our dedicated loan experts will walk you through it all, and our mortgage application is fast, simple, and convenient. The best part? Borrowers are eligible for a 0.125% discount on our already low interest rates.