Preparing to buy a home? You’ve likely heard that you first need to save 20 percent of a home’s purchase price in cash.
That money is your down payment, or, the cash you put toward buying the home. The remaining 80 percent of the home’s price comes from the mortgage you take out with a lender.
The lender underwrites the loan, you add the money you borrow in order to buy the home, and then you make monthly payments on your mortgage loan for the next 30 years (or until you sell and pay the loan back with the cash received from the sale).
That’s the traditional way of buying a home. But it’s not the only way, which is good news for a lot of potential homeowners.
You Don’t Need to Save 20 percent to Buy a Home
A 20 percent down payment is the recommended amount, and there are good reasons for that. But it’s not a hard-and-fast rule. You can buy a home with less than 20 percent down.
Many people even choose to put less than 20 percent down on a home because it means keeping more cash in their pockets (or in other investments that generate a higher return than paying down your mortgage). Homes are assets, but they’re illiquid. Cash is liquid and much more flexible.
Plus, a big down payment puts you at risk of losing money on your property if the home value drops between the time you bought and the time you want to sell.
There are mortgage types and certain lenders who will approve you with as little as 3 percent down toward your home purchase. And you can still get a conventional, 30-year fixed-rate mortgage with 10 percent down.
Here’s a quick list of minimum required down payments for common home loans– which are all well below 20 percent:
- No down payment required for VA loans
- 3 percent minimum for a conventional loan with PMI
- 5 percent down for FHA loans
- 10 percent down payment required for jumbo loans
But these options have certain drawbacks. Namely, they require higher loan amounts and higher monthly payments – which could put your finances at risk.
Best of Both Worlds: Down Payment Matching Programs
You could also take advantage of the Unison HomeBuyer program to get the mortgage you want while putting down 10 percent or less of your own cash.
Unison works with homebuyers to invest alongside them in their homes. Rather than borrowing money from a bank, buyers partner with Unison and the company matches down payment funds so the buyer can have a full 20 percent down payment.
In return, Unison receives a share of the home’s appreciation or depreciation at the time the home is sold – up to 30 years later.
Again, this is an investment, not a loan. That means you never make monthly payments or interest charges. With this extra room in your budget, you are free to save money, make home improvements, or pay other expenses.
The Real Question: Can You Put Less than 20 percent Down and Avoid PMI?
The answer to “can I buy a home with less than 20 percent down?” is easy and straightforward: yes! The more complicated, and probably better, question to ask is, “can I put down less than 20 percent and avoid PMI?”
PMI is private mortgage insurance. A lender will take out a PMI policy to protect the money they lend to you to buy a home — and you pay the monthly premiums on that policy. If you ever default on your loan or fail to repay what you owe, the insurance company pays out to the lender.
Asking about avoiding PMI is a trickier question, because the answer is usually, “no.” That’s one of the drawbacks to putting less money down: lenders require PMI.
Private mortgage insurance can cost around $30-$70 per month for every $100,000 you borrow, according to Zillow. That means it could increase your mortgage payment by anywhere from $50 to $500 or more per month.
Fortunately, just because PMI is expensive doesn’t mean you don’t have any other options. Just like you can put down various down payment amounts, you can use a few different strategies to buy without PMI:
- Use a program and get a home ownership investment rather than taking out additional loans or paying PMI.
- Get a piggyback loan or an 80/10/10 loan. This requires you to take out two loans, a mortgage and a second loan for 10 percent of the home’s purchase price. You use that loan plus 10 percent of your own cash to create a 20 percent down payment on a home, and finance the other 80 percent with your mortgage.
What You Need to Know Before Putting Down Less Than 20 percent
All this being said, there are also some tradeoffs to putting down less. Before you choose to buy a home with less than 20 percent down, consider why that’s the rule of thumb.
The more money you put down, the lower your monthly mortgage payment will be. That gives you more breathing room in your monthly budget and can make the difference between stressing your cash flow and comfortably affording your home loan payment each month.
More cash upfront also means more equity immediately and gives you the ability to borrow less money for your mortgage. That, in turn, means paying less on your mortgage via interest, since your principle balance is smaller.
Another benefit of a smaller mortgage: smaller closing costs, since many of these fees are based on the size of your mortgage.
There are plenty of good reasons to put 20 percent down, so don’t skip out on saving up the cash you need simply because you can get away with putting down less.