Nobody Puts 20% Down on a House Anymore and Here’s Why
According to the Finance Policy Center, down payments are the largest obstacle that first-time homebuyers face.
However, this does not need to be the case. Because for some time now, not everybody is putting a 20% down payment on their house. In fact, according to NAR realtor, 80% of first-time homebuyers put down less than a 20% down payment.
Further research from them also revealed that while 60% of all homebuyers financed their purchase with a downpayment of under 6%, 87% of non-homeowners considered that a downpayment of 10% or more is required.
While, traditionally, low down payments are thought of as a risky move, in some cases it can prove riskier to invest a large down payment.
Why is this?
Keep reading to find this out, as well as why low down payments are not necessarily a bad thing, and how to weigh up your options when it comes to down payments so that you can make a decision that is right for you.
20% Is Just the Industry ‘Standard’—It’s Not the Rule
Traditionally, all conventional loans were set at a 20% down payment threshold.
Because of this, many people still think that this is the ‘rule’. It is not.
For some loans, such as FHA loans, you can make a minimum downpayment of 3.5%, and VA loans require no down payment.
Additionally, with conventional housing loans, if you take out private mortgage insurance, you are eligible for a minimum downpayment of 3%.
It Is Possible to Make Very Low Down Payments
As you can see, it is possible for just about anybody to make a low downpayment when purchasing a house.
Previously, it was thought that this was a risky route. However, this perception is changing. The reason for this is that there are a number of circumstantial factors that can interplay to determine whether a high down payment or a low down payment is best.
The downside to low down payments is that they will increase your monthly mortgage fees, and will incur monthly PMI costs.
However, they hold a number of noteworthy benefits, which is why many people are taking advantage of them.
Aiming for a Large Down Payment Can Allow Housing Prices to Get Away from You
One of the first considerations you need to make when aiming for a high down payment is how this is going to affect your buying power.
By saving for a long period in order to make a down payment of 20%, you may find that by the time you are ready to buy, the market has overtaken you and the houses that you want are out of your price range.
According to further research from NAR Realtor, 24% of people are delayed in buying a home for over 5 years, thanks to the necessity to save for a downpayment while meeting other debt.
As most people have student debt and other financial commitments to meet, saving for a 20% down payment can take a long time, so long in some cases that it can be to one’s financial detriment.
Big Down Payments Can Deplete Other Personal Assets
Another reason why people are turning to low down payments is to avoid depleting their other assets.
These can be things like college funds, retirement annuities, and cash savings, all of which are important assets—which can take a considerable amount of time to build back up.
If you have been saving up cash for the purpose of buying a home, then it is worthwhile to consider whether it is wise to spend it all on a downpayment.
Having a cushion of cash savings is always a smart move, especially if you are a first-time homeowner. Homeownership often comes with a number of unforeseen costs. Additionally, the pressure of mortgage payments can make it more difficult to weather personal events such as medical emergencies and other surprise expenses.
For these reasons, in many cases, it can be to your advantage to have cash savings on hand father than increased home equity.
Large Down Payments Can Be Risky
Although larger down payments of 20% or more are often viewed as the least risky option, this is not always true.
One of the reasons for this is that cash savings are liquid, while housing equity is not. As soon as you use your cash savings as a down payment, that money is converted into home equity.
To convert home equity back into cash, you can either choose to sell your home or refinance it. Both of these options take time. Home refinancing also requires a certain amount of equity (you cannot always barrow 100% of available equity), and additional transaction fees.
Selling your property can take even longer and cost you more equity in fees.
Vulnerability to Housing Slumps
If the market value of your house drops, this can effectively eat up the equity that you put into your home through your downpayment.
Additionally, banks can be more likely to close on homeowners with larger equity, as that money has already been recovered by the bank, therefore they have a higher chance of reclaiming the leftover loss.
On the other hand, homes, where low down payments were made, pose more of a risk to banks at foreclosure as they can suffer significant losses due to not being able to claim much of the equity.
The Down Payment You Choose Should Depend on Your Needs
The best down payment amount to choose will always depend on your personal circumstances.
For example, if you have substantial savings, but lower monthly income, then a large down payment might be best, as this will reduce your monthly mortgage liability and you will not have the expense of PMI that comes with down payments under 20%.
Conversely, if you do not have substantial savings, but do have a high monthly income, choosing to take the option of a low downpayment in order to get into the housing market might be a wise move.
If you are trying to work out which option is best for you, use a mortgage calculator to calculate what size down payment is most practical for your finances.
Drop the Stigma Around Down Payment Sizes
Thanks to the traditional loan threshold and lack of knowledge around modern down payment options and their pros and cons, there exists, to some extent, a stigma around low downpayment.
However, low down payments are neither good nor bad. They merely come with a different set of pros and cons. In order to make the right decision for your best interest, you will need to factor these in and choose an option that will serve your specific needs.