Do You Actually Need 20% Down to Buy a House? We Bust the Myth

You’re getting serious about becoming a homeowner, but your savings account has some catching up to do. You wonder how big a down payment you need to secure a mortgage: 20%, 10%, 3.5%, or none at all?

Really, the answer is any of the above — though that comes with some caveats. Saving for a home is one of those scenarios where you don’t want to let the perfect (i.e. 20% or more down) be the enemy of the good.

“There is a myth that you need 20% down, but that just isn’t the case,” says top Myrtle Beach, S.C., real estate agent Abe Safa, who has nearly a decade of experience and completed more than 170 transactions. There are several homebuying assistance programs for buyers with modest down payments, he says.

If 20% is out of your reach, here’s how to determine just how much money you should have saved for a down payment.

The myth of 20% down

Wondering how your peers may have been able to save 20% down and whether your own savings strategy is good enough? Something to keep in mind: Many homebuyers are relying on gifts to help cover the down payment.

According to a 2019 report from the National Association of Realtors, 12% of all homebuyers (and 28% of buyers under 28) relied on a financial gift from friends or family to help cover the down payment.

This process, though, goes beyond simply cashing a check. You’ll also need a gift letter (at the very least) to confirm the money is indeed a gift and not a loan.

While 20% down has emerged as a gold standard in homebuying, and many buyers are able to get there with the help of gift money from family, this isn’t a one-size-fits-all process.

In fact, the average down payment on a house in 2019 was far less than 20%. First-time buyers who financed their homes put down an average of 6.7%, according to a report from the National Association of Realtors. Repeat buyers, on the other hand, typically put down 16%, according to the report. Another study from Lodestar Software Solutions found that 5.3% was the average down payment.

Experts say there are plenty of scenarios where it makes sense to put less money down: If it would take you several years to save 20%, for instance, market growth could outpace your ability to save, putting homeownership out of reach.

Putting 7% down in some markets is much easier than it is in others. Money magazine partnered with real estate property company Attom Data Solutions to build a map of how much you’d need for a 7% down payment in every state.

Here’s a sampling of their analysis of median down payments: 

$34,930 in California

$25,326 in Colorado

$21,630 in New York

$12,600 in Michigan

$11,713 in Kansas

Is bigger really better when it comes to down payments?

Putting 20% down may have some perks, but by no means is it the only path to homeownership. The main perk of putting 20% down on a home loan is that you likely get to avoid private mortgage insurance, or PMI on a conventional loan, or government-backed mortgage insurance (MI) on a government loan such as FHA or VA.

When you have less than 20% to put down on the loan you have less invested in the property so many lenders consider you a riskier buyer and will typically add PMI or MI, an extra fee that helps protect them in case of default.

Typically, MI costs between 0.5% and 1% of the mortgage loan amount on an annual basis. That can hike up your monthly mortgage payments quite a bit.

Let’s do the math: 

Let’s say you qualify for a conventional loan where  you’re paying a 1% PMI fee on a $350,000 loan. You’d be paying an extra $3,500 a year, or $292 a month.

Keep in mind that for conventional loans, PMI isn’t a fee you’ll pay forever. In many circumstances, the PMI is canceled when your principal balance reaches 78% of the original value of your home, according to the Consumer Financial Protection Bureau. But if you have an FHA loan, mortgage insurance can’t be canceled if you make a down payment that’s less than 10%. You could possibly do away with mortgage insurance payments down the road, though, if you refinanced with a non-FHA loan.

Tacking on a PMI payment to your mortgage may still be better than paying rent, especially as home values increase over time.

The other advantage of a big down payment is that you have more equity in your home, and you borrow less, meaning your monthly payments will be lower.

A healthy down payment could help tip a bid in your favor, too, explains Brian Koss, Executive Vice President at Mortgage Network, one of the largest independent mortgage lenders in the eastern U.S. If you don’t have 20% squirreled away, secure a strong pre-approval letter from a known lender. “The market has begun to level out and bring less bidding wars, making more of an even playing field for the low-down-payment offer,” he adds.

Putting 20% down could also have drawbacks. For example, will you have enough cash left over in savings for emergencies?

Furthermore, waiting for 20% to amass in your savings account could end up costing you. When interest rates are low, it’s a good time to get serious about buying a home, Safa says. Buying a home before rates go up can maximize your buying power.

Another big risk if you spend years stashing away 20%: Market growth could outpace your ability to save.

Let’s do some more math: 

You’re looking at homes for $350,000, and you know it will take you several more years before you can reach your target down payment of $70,000. If those same homes you’re eyeing today increase to $400,000 in a few years, you’d now need to save $80,000 to put 20% down. If you had bought earlier with a lower down payment, the growth in equity would have canceled out your PMI sooner, too.

How low can you go on the down payment? 

Lack of a down payment can be a major hurdle to homeownership. If your inability to save 5 figures quickly is holding you back, know this: There are lots of low down payment options out there.

In fact, VA loans require no down payment — zip, zero, zilch! — and don’t have any PMI requirements, according to the U.S. Department of Veterans Affairs. Most members of the regular military, as well as veterans, reservists, and members of the National Guard are eligible to apply for a VA loan.

FHA loans are another option for those with lower income or lower-than-average credit scores. If you have a credit score of 580 or above, you may qualify for an FHA loan with only 3.5% down. If you have a 500 credit score, you could get an FHA loan with 10% down.

A knowledgeable lender will be able to connect you with first-time buyer programs that align with your needs.

Other examples include a U.S. Department of Agriculture home loan program that assists low-income and moderate-income buyers in rural areas; it doesn’t require down payments. The HUD “Good Neighbor Next Door” program offers eligible homes at a 50% discount to law enforcement officers, teachers, firefighters, and EMTs with a scanty $100 down payment. Many states also have down payment assistance programs, oftentimes with income limits.

Now, cue the limbo music: How low can you go? Is it really a good idea to put no money down or to make a small down payment, like 3.5%?

This really depends on your situation. Some would say that buying a home, even with a low down payment, is a smart idea when interest rates are low and your monthly housing payments will be building your equity instead of a landlord’s bottom line. Plus, your property value could increase, ultimately contributing further to your nest egg.

But, running your numbers and making sure you can afford a house is critical. Some potential extras to budget for include HOA fees, taxes, insurance, and a homeowners’ maintenance fund. Don’t forget about closing costs, which can climb up to 5% of the total home sale amount and cause some major sticker shock. If it’s feeling like too big of a stretch once all of these additional costs are factored in, this could be a sign that you’ll have a tough time making your monthly mortgage payments.

How to put less than 20% down

If you’re thinking about buying a home, but know you won’t be able to save up 20%, a few strategies can help give you sound financial footing.

Work on improving your credit

Getting your credit score in tip-top shape is key,  Safa says. “That’s going to determine what your interest rate will be, which, in turn, can save you a good deal of money,” he says.

Consult with a financial advisor and lender

Working in tandem with a financial adviser and a lender could help you determine how to reach your down payment sweet spot.

A financial adviser, for example, might be able to help you weigh the pros and cons of borrowing from your retirement account to cover your down payment.

Meanwhile, a lender will be able to zero in on homebuying specifics, including what homebuyer grants you might qualify for and how you could bump your credit up by 10 or 20 points to leverage a better interest rate.

Talk to your real estate agent

Your real estate agent can make recommendations for lenders who can work with your current down payment situations; you can also seek recommendations from family members or friends. But as you’re considering lenders, be sure to ask some questions that are specific to your homebuying scenario.

For instance, if you’ve served in the military, does the lender have experience with VA loans? If you need to get to the closing table quickly so you don’t have to pay month-to-month rent premiums, ask potential lenders about their turnaround times for pre-approval letters and, on average, how quickly they can close a loan. What will the lender fees be?

Every individual has different priorities when shopping for homes, whether it’s a preference for craftsman architecture over mid-century modern or a sprawling backyard over a walk-in closet. Remember that the financing portion of purchasing a home is unique to you, too.

Header Image Source: (Mackenzie Freemire/ Death to the Stock Photo)