3 Things to Know About a 20% Down Payment

Joanna Campione
Joanna Campione

A whopping 20% down.

It’s what most lenders want to see as a down payment from a potential home buyer.
For the buyer, it likely means a lower mortgage rate, lower monthly payments, and more home equity. For the banks and other lenders, it’s a sign that the buyer has the financial wherewithal to own a home.

But not every buyer can come up with 20% to put down on a home, especially with home prices on the rise nationally. In August, the median home price jumped 5.6% from a year earlier, to $253,500. That marked the 66th straight month of price gains, year over year.

Here are three things you should know about a 20% down payment.

#1 Without it, you pay more

Most lenders want to see that sizable down payment, and it’s not because they are trying to be difficult. They are doling out a lot of cash to help you get in a home and that 20% of the selling price gives them confidence that you, the buyer, can handle the home loan. Most first-time homebuyers aren’t even aware of the 20% down payment standard. A report from Bank of America found that only 29% of prospective home buyers believed they needed 20% down. More than two out of five thought a down payment should be 10% or less.

Of course, if you put less down, you’re going to pay more each month and over the life of the loan in interest. But also, without putting that 20% down, most buyers have to pay Private Mortgage Insurance (PMI). PMI is a protection for the lender in case of default, and it’s an extra monthly cost. “The total cost depends on the loan-to-value ratio and credit score, not to mention geography,” says Lynn Fisher, vice president of research and economics at Mortgage Bankers Association (MBA). Fisher says the typical cost is in the range of 75 to 100 basis points, or about .75 to 1% of the loan.

#2 Many home buyers don’t do it

Even though paying for the home with less down costs more in the long run, many Americans don’t make a 20% down payment. According to the National Association of Realtors (NAR), fewer than 6 out of 10 of home buyers who bought a home with a mortgage through July came up with a 20% down payment. The median down payment so far this year is 10% of the selling price. For first-time buyers, the rate is much lower, at 6%, says the NAR.

There are plenty of options out there that require low down payments. FHA, VA, and USDA all offer home loans with little to no money down for qualified buyers.

“From consumers’ point of view, the most important thing is to stay well within budget,” says Lawrence Yun, chief economist and senior vice president of research at NAR. “Low down payments can still lead to successful homeownership.”

#3 Higher down payments give buyers a leg up

It’s not just lenders who like to see a 20% down payment on a home. Sellers like it too. Housing inventory is tight, particularly for starter homes. On a year-over-year basis, housing inventory has dropped every month for the past 27 months.

With inventory dropping, a report from Trulia finds there is a mismatch between the number of buyers and starter or trade-up homes currently on the market. While higher-priced listings are “saturating the market on the national level,” Trulia says it has seen searches for starter and trade-up homes on its site making up a growing share of all search activity.

That means more competition for homes in the lower price range — and more bidding wars. In deadlocked bidding wars, sellers tend to go with a buyer who is putting more money down.

“Putting 20% down will help because it is a sign to the seller that you are financially able,” says Cheryl Young, senior economist at Trulia. “If you are putting less down, you may have to jump through more hoops to get financing.”

Big decisions

So, should you scrounge around for 20% to put down on a new home, borrowing against 401(k)s, IRAs, asking for money from family and friends? Put less down? Wait to buy a home? It depends on your budget and if you can keep up with the month-to-month costs of owning that home.

But it also depends on where you are in life, says MBA’s Lynn Fisher. “If you are near retirement, maybe you need to get your payment to a certain level each month, or you want to reduce your debt as quickly as possible.” In that case, she says, the sizable down payment makes sense. But if someone is younger with a steady income, then it’s an investment decision, she says.

“You have to think about the opportunity cost of putting more money down — that is, the rate of return if you invest that money somewhere else,” she says.

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