Mastering the Art of the Down Payment

by Jeff Ostrowski
October 23, 2017

You’ve heard this bit of conventional wisdom countless times: Before shopping for a home, stash away enough cash for a 20 percent down payment.

But is 20 percent mandatory? Nope.

Like many rules of thumb in the world of money, the 20 percent suggestion is based on sound advice, but it’s far from your only option.

You can qualify for a traditional mortgage with as little as 3 percent down – and, if you’ve served in the armed forces, you can get a Department of Veterans Affairs (VA) loan with no down payment. At the other end of the spectrum, cash-rich buyers can write a check for the entire amount of the sale price and borrow nothing. Most buyers, of course, fall somewhere in between.

Why 20 percent down matters

Here’s why the 20 percent rule of thumb endures: If you put down less than 20 percent, your lender will require that you pay for something called mortgage insurance. This coverage protects the lender (not you) in case you default on your loan, but monthly mortgage insurance premiums can cost hundreds or even thousands of dollars a year.

So mortgage insurance creates a strong incentive to cobble together a 20 percent down payment. It’s also a high hurdle for potential buyers struggling to pay student loans and cope with rising rents. The typical American home sold in September fetched more than $245,000, and a 20 percent down payment equates to just under $50,000.

But what if you can’t come up with the equivalent of a typical American’s annual salary?

Don’t sweat it too much, says Dawn Rae, a real estate agent in St. Petersburg, Florida, and past president of the National Association of Exclusive Buyer Agents.

“If you can do 10 percent or even 20 percent, that’s the way to go,” Rae says. “But if you have less, I wouldn’t let it stop you.”

Put down what’s reasonable

The mortgage market has veered wildly in recent years, so potential homebuyers can be forgiven for being confused about what constitutes a reasonable down payment. During the housing bubble, zero-down mortgages were all the rage. And during the crash, it was nearly impossible to buy a house with less than 20 percent down.

“So many people have a lack of awareness of the options,” says Rob Chrane, chief executive of Down Payment Resource in Atlanta. “A significant amount of non-homeowners overestimate the amount they need to put down. As a result, there are literally millions of people who are mortgage-ready and don’t know it.”

As the mortgage market returns to normal, Fannie Mae and Freddie Mac have begun offering loans with as little as 3 percent down. And the Federal Housing Administration long has offered loans with as little as 3.5 percent down, although FHA mortgage insurance premiums are steep.

Mortgage insurance isn’t all bad

Scott Schang, a California mortgage broker who writes about mortgage matters at FindMyWayHome.com, says too many buyers go too far to avoid mortgage insurance.

“For some reason, many people have a very negative opinion of mortgage insurance,” Schang says. “I personally think it should be considered as part of the investment of owning real estate. To look at it another way, you’re essentially financing your down payment. The mortgage insurance is the financing cost.”

Chrane agrees. Paying mortgage insurance isn’t ideal, but it might be a better option than the alternative. If you have enough for a 10 percent down payment, it could make sense to buy now rather than continuing to rent as home prices increase, mortgage rates edge up and rents rise.

Seek out financial help

Don’t overlook down payment assistance. Many states and municipalities and even some employers offer grants or low-interest loans to help with down payments. And you need not be poor to qualify – some programs are open to borrowers with $100,000 incomes.

Another option: See if your closing costs can be covered through lender credit, by the seller or by your real estate agent.

“By covering closing costs through one of these means, you can apply more of your own money towards the down payment, reducing your loan amount and ultimately your payment,” Schang says.

Chrane offers another bit of advice: Don’t stretch so far to scrimp together a down payment that you’re left with no money for living expenses.

“I’ve been to so many closings where the buyer says, ‘We’re going to be eating tuna out of a can for six months while we adjust to this,’” he says.

He also warns against dipping into your retirement account to come up with a down payment.

As with many financial decisions, the experts say, there’s no perfect answer about how much to put down. Weigh your financial situation, including your monthly budget and how much private mortgage insurance will cost with various levels of a down payment.

Veteran business journalist Jeff Ostrowski is a regular contributor to MoneyGeek.com who has written hundreds of news stories about real estate, personal finance, insurance and other money matters.

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