Taking the plunge into homeownership can be a big undertaking. And in a hot real estate market like this, it's no wonder families are stressed out trying to make homeownership a reality.
One major topic that comes up time and time again is around the home down payment and if you REALLY need to go for 20% down or not.
Recently, I received a question from Juan on this very topic and here it is:
“We're in New York and want to buy a house. Is 15% okay instead of 20% for your home down payment?”
Ultimately, this is a personal decision that has financial ramifications to it.
Let’s review both sides of this decision by reviewing the 20% home down payment pros and cons.
Pros of a 20% Home Down Payment
1. Avoid PMI
With most conventional mortgages, putting 20% or more down helps you to avoid private mortgage insurance (PMI). This is an additional lender fee that can be upwards of 1% of your loan.
Let’s say you’re shopping in the $500,000 range for a new home.
If you dip below a 20% down payment, not only will your monthly mortgage payment be higher, but the PMI will steal more of your money each month. So if you only put 15% down on this $500,000 home, you could owe an additional $354 per month (or $4,250 annually).
If you go with 20% down, you avoid the PMI. Instead of a $75,000 down payment, you’d need a $100,000 down payment.
That’s a tall order, but it could be worth it in the long run.
(If you’re talking New York City, New York, who knows, you may need to double my example numbers here Juan!)
2. Higher Down Payments, Help With Lower Interest Rates
The lower your loan to value ratio is … the lower your interest rates can be!
This is because the bank or lender feels you are a less risky bet because you’re bringing more cash to the party.
For example, let’s say your $500,000 home has a $400,000 mortgage. Your loan-to-value ratio is 80%.
If you go with a 15% down instead, your loan-to-value increases to 85% because your mortgage is $425,000 instead of $400,000. It doesn’t sound like a huge difference, but let’s do some calculations to see.
I found a $500,000 home with a 20% down payment with a 15-year mortgage, in today’s market depending on your credit score, you could get a 2.92% rate which would make your monthly payments $2,691 per month (without taxes and insurance).
If you went with 15% down instead, your rate would go up to 2.95% and your monthly payments would be $2,859.
With that slightly higher loan-to-value ratio and the slightly higher risk for the lender, you’d be paying around $168 more per month for the life of your loan.
3. You’ll Have More Money for the Costs of Homeownership
Between the elimination of the PMI and the lower interest rate, we’re looking at eliminating around $500 per month if you go with 20% down instead of 15% down.
That’s not a small amount of money. As a new homeowner, that $500 could help you with the many many many costs that homeownership has to offer you!
These are often overlooked and they come and smack new homeowners in the face because we’re so fixated on the interest rates and mortgage payments!
I know this to be true because it happened to me when I put 10% down on my first home. In theory, I could “afford” the mortgage, but the real surprise to me was the stuff I wasn’t expecting as a previous renter.
- Utilities (electric, gas, water, etc)
- Home maintenance and repairs
- Lawn care
- Snow shoveling, clearing, blowing, plowing – however you deal with the snow, whether you pay for that or take care of it yourself. There’s still a cost.
Also, you’ll want to save up enough for these one-time expenses as well:
- Closing costs
- Updates to the house when you move in
- Furnishing the new home
- Painting the home
- Stuff you or your spouse might not think about but when you move in, you want it!
- Blinds – the blinds in our current house were so expensive!
There will be costs you need to be prepared for and having extra cash will definitely help with that unforeseen homeownership madness.
Cons of a 20% Home Down Payment
1. It Takes a Really Long Time to Save Up
Depending on your financial situation and the area of the country where you live, saving up 20% for your home down payment can feel like it takes a lifetime!
And a $500,000 house may sound like a fairytale to some of our listeners in Seattle where typical home values are around $900,000!
While folks living in Indianapolis their median home values are $208,000 … these folks might find that example to be high.
So this all depends on where you live, but it also depends on what you make. Someone making $200,000 per year living in Indianapolis will have a much easier time buying a home than someone making $200,000 per year in Seattle.
Since everyone’s situation is different, the amount of time it takes for you to save up this down payment will be different too.
2. Housing Prices Are Rising Like Crazy
In 2021, national housing prices rose by 19%!
When you’re saving your money in a high yield savings account at 0.05%, it’s tough to see how you’ll ever catch up to housing prices this fast.
Now, I’m not a fan of investing your home down payment money due to the volatility of the market and my past experience doing this in such a short timeframe.
Depending on where you live in the country 19% might be incredibly high or low.
For example, Austin’s home prices rose by 30% in 2021.
And for our buddy Juan, prices in Manhattan are down compared to all-time highs in 2017. This probably has a lot to do with the pandemic and people leaving the city for the suburbs.
Again, this surge in pricing is all relative to where you live.
3. Interest Rates are Rising
The Federal Reserve recently raised interest rates and they are expected to do so 6 more times this year. That means mortgage interest rates are likely to increase as well.
So taking the time to save up for a 20% down payment might mean your rate and your monthly payment will be higher. Depending on how the economy looks as the year rolls on, getting a mortgage may continue to get more expensive.
Is Less Than a 20% Home Down Payment Okay?
Now that we’ve looked at both of the pros and cons of a 20% home down payment in this market, I’m going to share what I’d do if I were in your shoes.
Crunch Some Numbers
Do the math and see how long it’ll REALLY take you to save up the 20% you need. Is it really gonna be FOREVER? Or just like another year?
If it’s within a reasonable timeframe (and reasonable is only something you can answer), then I’d keep plugging away at your savings until you get to 20%.
Increase Your Income
Can you increase your income during this period of time in your life? If so, go for it!
The best place to start with increasing your income is where you already making money.
Is it time for a raise? Can you get some bonuses? Commissions? Referral fees?
Find out ways to increase your income at work. If there are no opportunities there, can you work a side hustle for a period of time so your homeownership experience is something you actually enjoy?!
Or maybe you have some stuff lying around your place that you could sell on Facebook Marketplace that you don't use anymore.
I believe this extra hustle will be worth it in the long run.
Decrease Your Expenses
Really look over your budget and see where you can decrease your expenses for the time being.
Look at the big expenses first. Housing, transportation and food, and then the smaller stuff.
Your extra attention here could make a huge difference.
Consider a Less Expensive Home
If homeownership is VERY important to you, but your exact location is not, consider looking around for a less expensive area.
Or perhaps the area is VERY important, but you could get away with a smaller place. Consider that!
Being flexible will allow you to make homeownership a reality much sooner.
Do Your Thing
After you’ve done all of these things and you still really want to buy a house with less than 20% down, go for it! After all, most people in our county do.
According to the National Realtors Association in 2021, the average home down payment was 12%. And for folks under 30, that dropped to 6%.
So, it’s not like your doing anything wrong by going with less than a 20% down payment. There are just some financial ramifications to it. And we’ve covered those.
If you’re aware of those financial ramifications and you're financially prepared to battle them, then get that home of your dreams.
Final Thoughts on 20% Home Down Payment Pros and Cons
I hope that helps with your decision to buy your new home with a 20% down payment or not.
It’s a really big decision to buy a home. In fact, it’s the biggest single purchase most people make in their lifetime.
So while it feels like you need to rush and get your down payment down as fast as possible given the rising home prices and interest rates, it might make sense to slow down.
After all, there’s no race here. There will be a home for you eventually. You’ll be living as a homeowner soon.
I’m hoping it’ll be as a happy homeowner and not one that feels owned by their home.
What would you add to this list of 20% home down payment pros and cons? Do you think 10% or 15% is fine?
Please let us know in the comments below.