Looking at the Down Payment: Can You Put Down Less Than 20%?

What is the minimum down payment on a house? When buying a home, one of the common "rules" is to save up 20% of the purchase price as a down payment. Many people erroneously believe that it's just not possible to get a good mortgage without placing 20% down.

A better question would be, what is a good down payment on a house? For home buyers who don't have that amount of money available or don't want to take draw down their savings or investments, it's not always necessary to have 20% as your calculated down payment. Many conventional loans can be obtained for 10% or even 5% down, FHA requires 3.5% down, and some USDA loans are zero-down programs. So, is there ever a time where putting less down can make sense?

Remember to ask a lender and/or financial advisor to understand your financial picture as it relates to a potential mortgage.

Don't Use all Your Savings for a Downpayment

If putting 20% down on a house would use all your savings, think before doing so. What happens when the home suddenly needs some repair work, or there's an unexpected problem or an unforeseen bill to pay? People who may not have some money set-aside or in savings might get into a bind as a homeowner, simply because they no longer have the resources to handle financial issues that can arise. Strapped homeowners may find themselves borrowing from credit cards, or letting things slide because they can't pay for them right now. This could lead to deferred home maintenance issues or other financial problems that could have been avoided.

Taking part of a savings account to put 20% down on a house sometimes makes sense, but depleting an account entirely or leaving a very small amount available for emergencies may not work for every home buyer. Many savings accounts also earn interest, even if the percentages are small. So not only would depleting the account mean there's no cushion for problems or emergencies, but it could also mean that a way of earning some extra money every month has been lost. Depending on the amount of money that would be left in the savings account, a smaller down payment could possibly leave enough to deal with unforeseen issues comfortably.

How Are Those Investments Doing?

If there are investments that the down payment would have to come from, it might be wise to leave that money alone and use a lower down payment option for the mortgage. Some investments have penalties if the money is pulled out of them before a specific period of time has elapsed, or before the investor reaches a particular age. Other investments don't have these restrictions, but they might be performing too well to take money out of them. Some buyers forego pulling money from an investment if it's earning more interest than they would be paying on a mortgage (and PMI). 

Additionally, the main reasons why people say that home buyers should put 20% down is to build some equity and avoid PMI. The equity argument makes sense for many buyers, but the cost of the PMI may be lower than the amount you would earn if you left the money in an investment. It's important to figure out where you stand financially, so the right decision can be made about how much money should be used for a minimum down payment. Investments that are earning a good rate of return, though, are commonly left alone so they have the opportunity to grow and provide a stronger financial future.

What is PMI and What Does it Cost?

PMI, or Private Mortgage Insurance, is used by lenders when buyers don't put 20% down on their home. It helps to protect the lender if the buyer defaults, and statistics show that buyers with lower levels of equity are the most likely to default on their mortgages. Many of these kinds of home and land buyers don't have a lot of money for a down payment, and because they didn't put much down, they aren't as invested in the home and what happens to it. Of course, not all buyers are like that when they put a lower amount down. The cost of PMI shouldn't always stop serious buyers from getting a money even if a 20% down payment isn't possible.

The cost of PMI will vary based on the loan, the lender, and other factors. It can be a few dollars per month, or hundreds of dollars per month. The higher the price of the home and the amount of the loan, the more PMI a buyer can expect to pay. Additionally, an FHA loan may have a higher PMI requirement than a conventional loan. It's important to remember that PMI generally can't be dropped on an FHA loan when a buyer reaches 20% loan-to-value, either, but it may be dropped at that point with a conventional loan. Many FHA buyers refinance to conventional at some point, to get rid of their PMI payment.

The Piggyback Loan or Second Mortgage

Can you get a loan for a down payment? Yes, another way to possibly avoid putting 20% down, and also avoid PMI, is to take out a second mortgage or a piggyback down payment loan when the home is purchased. In this case, you would get a loan for 80% of the home's value, which is enough to avoid PMI. Then you would get a second loan for 10%, and put 10% down. That stops the need for PMI, but also keeps the buyer from needing a 20% down payment, so money can stay in investments or savings accounts.

Of course, buyers need good credit and a willing lender for this to take place, so it's important to check your credit report and shop around before deciding how to proceed. Not every lender will be open to this option, but some of them are.

Choosing to Put 20% Down

For people who don't have investments that are performing really well, or those who have plenty of savings over and above the amount they would need, putting 20% or even more down on a house may make sense.

It's not that the 20% rule should be avoided - only that there are other options to consider. Sometimes those other options work better in certain situations than what is traditionally expected, so taking a careful look at different ways to finance a home purchase and protect savings and investments is worth the research. It could result in a great home buying experience and a better, more stable financial future, which is a winning combination for any homeowner.