Before making a 20% mortgage down payment, read this

Dan Green
The Mortgage Reports contributor

How much do you have to put down on a house?

First things first: The idea that you have to put 20 percent down on a house is a myth.

The average first-time home buyer puts just 6% down, and certain loan programs allow as little as 3% or even zero down

You shouldn’t think it’s conservative to make a large down payment on a home, or risky to make a small down payment. The right amount depends on your current savings and your home buying goals. 

If you can buy a house with less money down and become a homeowner sooner, that’s often the right choice.

Verify your low-down-payment loan eligibility (Jun 17th, 2021)

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How much is a down payment on a house?

How much down payment you need for a house depends on which type of mortgage you get.

The most popular loan option, a conventional mortgage, starts at 3% to 5% down. On a $250,000 house, that’s a $7,500-$12,500 down payment.

But to avoid private mortgage insurance on one of these loans (which costs extra every month) you need 20% down. That’s $50,000 on a $250,000 home.

FHA loans let you buy with 3.5% down, which would be $8,750 on the same house. 

Some loan types will even let you buy with zero down.

These include government-backed USDA and VA loans, which let you finance 100% of the home price and put $0 toward the purchase price. However, you’ll likely still have to cover some or all of your upfront closing costs with cash. 

So, you only need to put down around 3-5% in most cases. But that begs the question: How much money should you put down? 

How much should you put down on a house?

Should you put 20% down on a house, even though it’s not required? In many cases, the answer is no. In fact, most people put only 6-12% down. But the right amount depends on your situation. 

For instance: If you have a lot of money saved up in the bank, but relatively low income, making the biggest down payment possible can be smart. That’s because a large down payment shrinks your loan amount and reduces your monthly mortgage payment.

Or maybe your situation is reversed.

Maybe you may have a good household income but very little saved in the bank. In this instance, it may be best to use a low- or no-down-payment loan, while planning to cancel your mortgage insurance at some point in the future.

At the end of the day, the “right” downpayment depends on your finances and the home you plan to buy.

Check your down payment options (Jun 17th, 2021)

Benefits of a 20% down payment

A large down payment helps you afford more house with the same monthly income.

Say a buyer wants to spend $1,000 per month for principal, interest, and mortgage insurance (when required). Making a 20% down payment instead of a 3% down payment raises their home buying budget by over $100,000 — all while maintaining the same monthly payment.

Here’s how much house the homebuyer in this example can purchase at a 4% mortgage rate. The home price varies with the amount the buyer puts down.

Down Payment (%) Down Payment ($) Monthly Payment (Principal & Interest / PMI) Home Price You Can Afford
3%   $884 / $116 $154,500
5% $8,780 $896 / $104 $175,500
10% $91,310 $913 / $87 $193,000
20% $52,370 $1,000 / $0 $261,500

Even though a large down payment can help you afford more, by no means should home buyers use their last dollar to stretch their down payment level.

And, as the charts below show, you don’t save a ton of money each month by putting a lot down.

Comparison of down payment and monthly payment per loan program (FHA, VA, USDA, Conv 97, 5% down, 10% down)

Making a $75,000 down payment on a $300,000 home, you only save $500 per month compared to a zero-down loan.

Drawbacks of putting 20% down

As a homeowner, it’s likely that your home will be your biggest asset. The property may even be worth more than all your other investments combined.

In this way, your home is both a shelter and an investment. And once we view our home as an investment, it can guide the decisions we make about our money.

The riskiest decision we can make when purchasing a new home? Making too big of a down payment.

A big down payment will lower your rate of return

The first reason why conservative investors should monitor their down payment size is that the down payment will limit your home’s return on investment.

Consider a home which appreciates at the national average of near 5 percent.

Today, your home is worth $400,000. In a year, it’s worth $420,000. Regardless of your down payment, the home is worth twenty-thousand dollars more.

That down payment affected your rate of return.

  • With 20% down on the home — $80,000 –your rate of return is 25%
  • With 3% down on the home — $12,000 — your rate of return is 167%

That’s a huge difference.

However! We must also consider the higher mortgage rate plus mandatory private mortgage insurance which accompanies a conventional 3%-down loan like this. Low-down-payment loans can cost more each month.

Assuming a 175 basis point (1.75%) bump from rate and PMI combined, we find that a low-down-payment homeowner pays an extra $6,780 per year to live in its home.

With three percent down, and making an adjustment for rate and PMI, the rate of return on a low-down-payment loan is still 105 percent.

The less you put down, the larger your potential return on investment.

Check your eligibility for a low down payment loan (Jun 17th, 2021)

Once you make your down payment, you can’t get the money back easily

There are other down payment considerations, too.

Once you make a down payment, you can’t access that money unless you sell the house or take out a loan against it.

This is because, at the time of purchase, whatever down payment you make on the home gets converted immediately from cash into a different type of asset known as ‘home equity.’

Home equity is the monetary difference between what your home is worth on paper, and what is owed to the bank.

Unlike cash, home equity is an ‘illiquid asset,’ which means that it can’t be readily accessed or spent.

All things equal, it’s better to hold liquid assets as an investor as compared to illiquid assets. In case of an emergency, you can use your liquid assets to relieve some of the pressure.

It’s among the reasons why conservative investors prefer making as small of a down payment as possible.

When you make a small down payment, you keep your cash in your pocket rather than tying it up in real estate.

By contrast, when you make a large down payment, those monies get tied up with the bank and you can only access them by selling, refinancing, or taking out a home equity loan.

It’s nice to make a large down payment because it lowers your monthly payment — you can see that on a mortgage calculator. But when you make a large down payment at the expense of your own liquidity, you may put yourself at risk.

You’re at risk when your home value drops

A third reason to consider a smaller down payment is the link between the economy and U.S. home prices.

In general, as the U.S. economy improves, home values rise. And, conversely, when the U.S. economy sags, home values sink.

Because of this link between the economy and home values, buyers who make a large down payment find themselves over-exposed to an economic downturn as compared to buyers whose down payments are small.

We can use a real-world example from last decade’s housing market downturn to highlight this type of connection.

Consider the purchase of a $400,000 home and two home buyers, each with different ideas about how to buy a home.

One buyer is makes a twenty percent down payment in order to avoid paying private mortgage insurance to their bank. The other buyer wants to stay as liquid as possible, choosing to use the FHA mortgage program, which allows for a down payment of just 3.5%

At the time of purchase, the first buyer takes $80,000 from the bank and converts it to illiquid home equity. The second buyer, using an FHA mortgage, puts $14,000 into the home.

Over the next two years, the economy takes a turn for the worse. Home values sink and, in some markets, values drop as much as twenty percent.

The buyers’ homes are now worth $320,000 and neither homeowner has a lick of home equity to its name.

However, there’s a big difference in their situations.

To the first buyer — the one who made the large down payment –$80,000 has evaporated into the housing market. That money is lost and cannot be recouped except through the housing market’s recovery.

To the second buyer, though, only $14,000 is gone. Yes, the home is “underwater” at this point, with more money owed on the home than what the home is worth, but that’s a risk that’s on the bank and not the borrower.

And, in the event of default, which homeowner do you think the bank would be more likely to foreclose upon?

It’s counter-intuitive, but the buyer who made a large down payment is less likely to get relief during a time of crisis and is more likely to face eviction.

Why is this true? Because when a homeowner has at least some equity, the bank’s losses are limited when the home is sold at foreclosure. The homeowner’s twenty percent home equity is already gone, after all, and the remaining losses can be absorbed by the bank.

Foreclosing on an underwater home, by contrast, can lead to great losses. All of the money lost is money lent or lost by the bank.

A conservative buyer will recognize, then, that investment risk increases with the size of down payment. The smaller the down payment, the smaller the risk.

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What is a down payment?

In real estate, a down payment is the amount of cash you put towards the purchase of home.

Down payments vary in size and are typically described in percentage terms as compared to the sale price of a home.

For example, if you’re buying a home for $400,000, you’re bringing $80,000 toward the purchase, your down payment is 20 percent.

Similarly, if you brought $12,000 cash to your closing, your down payment would be 3%.

The term “down payment” exists because very few people opt to pay for homes using cash. Their down payment is the difference between they buy and what they borrow.

Down payment requirements for mortgage loans

You can’t just choose your down payment size at random.

Depending on the mortgage program for which you’re applying, there’s going to be a specified minimum down payment amount.

For today’s most widely-used mortgage programs, down payment requirements are:

  • FHA Loan (backed by the Federal Housing Administration): 3.5% down payment minimum
  • VA Loan (backed by the Department of Veterans Affairs): No down payment required
  • Fannie Mae HomeReady Loan: 3% down minimum
  • Conventional Loan (with PMI): 3% minimum
  • Conventional Loan (without PMI): 20% minimum
  • USDA Loan (backed by the U.S. Department of Agriculture): No down payment required
  • Jumbo Loan: 10% down

Remember, though, that these requirements are just the minimum. As a mortgage borrower, it’s your right to put down as much on a home as you like and, in some cases, it can make sense to put down more.

Purchasing a condo with conventional loan is one such scenario.

Condo mortgage rates are approximately 12.5 basis points (0.125%) lower for loans where the loan-to-value ratio (LTV) is 75% or less.

Putting twenty-five percent down on a condo, therefore, gets you access to lower interest rates. So if you’re putting down twenty percent, consider an additional five and you’ll likely get a lower mortgage rate.

Making a larger down payment can shrink your costs with FHA loans, too.

Under the new FHA mortgage insurance rules, when you use a 30-year fixed rate FHA mortgage and make a down payment of 3.5 percent, your FHA mortgage insurance premium (MIP) is 0.85% annually.

However, when you increase your down payment to 5 percent, FHA MIP drops to 0.80%. This could save you money each month and over the life of the loan.

Verify your low down payment loan eligibility (Jun 17th, 2021)

What if I can’t afford the down payment?

Not everyone qualifies for a zero-down mortgage. Most borrowers need at least 3% down for a conventional mortgage or 3.5% down for an FHA loan.

But what if you can’t quite afford the minimum down payment? Three percent down on a $300,000 home is still $9,000 — a considerable amount of money.

Luckily there are programs that can help.

For example, every state has multiple down payment assistance programs (DPA). These programs — often funded by state and local governments and nonprofits — offer money to make homeownership more accessible for lower-income or disadvantaged home buyers.

DPA funds can come in the form of a grant or loan, and the loans are often forgiven if you live in the home for a certain period of time.

To find out whether you’re eligible for assistance, ask your Realtor or lender to help you find and apply for programs in your area.

20 percent down payment FAQ

Do I have to put 20% down on a house? 

You do not have to put 20 percent down on a house. In fact, the average down payment for first-time buyers is just 7 percent. And there are loan programs that let you put as little as zero down. However, a smaller down payment means a more expensive mortgage long-term. With less than 20 percent down on a house purchase, you will have a bigger loan and higher monthly payments. You’ll likely also have to pay for mortgage insurance, which can be expensive.

What is the 20% down rule?

The “20 percent down rule” is really a myth. Typically, mortgage lenders want you to put 20 percent down on a home purchase because it lowers their lending risk. It’s also a “rule” that most programs charge mortgage insurance if you put less than 20 percent down (though some loans avoid this). But it’s NOT a rule that you must put 20 percent down. Down payment options for major loan programs range from 0% to 3, 5, or 10% percent.

Is it better to make a large down payment on a house? 

It’s not always better to make a large down payment on a house. When it comes to making a down payment, the choice should depend on your own financial goals. It’s better to put 20 percent down if you want the lowest possible interest rate and monthly payment. But if you want to get into a house now and start building equity, it may be better to buy with a smaller down payment — say 5 to 10 percent down. You might also want to make a small down payment to avoid draining your savings. Remember, you can always refinance into a lower rate with no mortgage insurance later on down the road.

How can I avoid PMI without 20% down?

It’s possible to avoid PMI with less than 20% down. If you want to avoid PMI, look for lender-paid mortgage insurance, a piggyback loan, or a bank with special no-PMI loans. But remember, there’s no free lunch. To avoid PMI, you’ll likely have to pay a higher interest rate. And many banks with no-PMI loans have special qualifications, like being a first-time or low-income home buyer. 

What are the benefits of putting 20% down on a house? 

The biggest benefits of putting 20 percent down on a house are having a smaller loan size, lower monthly payments, and no mortgage insurance. For example, imagine you’re buying a house worth $300,000 at a 4% interest rate. With 20 percent down and no mortgage insurance, your monthly principal and interest payment comes out to $1,150. With 10 percent down and mortgage insurance included, payments jump to $1,450 per month. Here, putting 20 percent down instead of 10 saves you $300 per month.

Is it OK to put 10% down on a house?

It is absolutely ok to put 10 percent down on a house. In fact, first-time buyers put down only 6 percent on average. Just note that with 10 percent down, you’ll have a higher monthly payment than if you’d put 20 percent down. For example, a $300,000 home with a 4% mortgage rate would cost about $1,450 per month with 10 percent down, and just $1,150 per month with 20 percent down.

Do you have to pay PMI with 10% down?

The biggest drawback to putting 10 percent down is that you’ll likely have to pay mortgage insurance. Though if you use an FHA loan, a 10 percent or higher down payment shortens your mortgage insurance term to 11 years instead of the full loan term. Or you can put just 10% down and avoid mortgage insurance with a “piggyback loan,” which is a second, smaller loan that acts as part of your down payment.

What are today’s mortgage rates?

Today’s mortgage rates are still at historic lows, even for borrowers with less than 20% down. In fact, borrowers with low-down-payment government loans often get access to below-market rates.

So don’t write off home buying because you’re waiting to save 20% down. Many buyers can qualify today and don’t even know it.

Verify your new rate (Jun 17th, 2021)