Why Does a 20 Percent Down Payment Make Sense for Homebuyers?

When taking out a mortgage, lenders prefer that homebuyers put a 20 percent down payment upfront. Although mortgage rates remain historically low, home prices are expected to increase this year. Homebuyers might find the 20 percent down payment overwhelming, not to mention the closing costs, which is another upfront payment they need to settle.

The 20 percent down “ruling” is nothing but a myth as homebuyers could put a down payment for as low as 3 percent or none at all. However, some homebuyers who have saved enough funds and have anticipated the costs associated with homebuying may find it sensible to put a large down payment instead.

Homebuyers can get the best rates

Homebuyers might find it ideal to shop for a mortgage and get pre-approved as the average mortgage rate for a 30-year fixed-rate remains below 4 percent. When shopping for a mortgage, a homebuyer who has a good credit standing and is willing to put a 20 percent down can get the lowest interest rates that lenders could offer. Lenders offer the best rates to homebuyers who can put a 20 percent down because it significantly reduces their risk when lending money.

Mortgage insurance is not a requirement

Private Mortgage Insurance, or PMI, is only a requirement for homebuyers who put a down payment below 20 percent. It’s an additional cost that homebuyers need to pay to protect lenders in an event they could no longer continue making payments. Using Fannie Mae’s mortgage calculator for a 30-year fixed-rate mortgage, homebuyers who will put a 3 percent down for a $300,000 home with a 4 percent interest rate could have an estimated monthly PMI of around $267 on top of the $1,952 monthly mortgage they need to pay. That’s a total of $2,219 every month. PMI is a requirement for homebuyers until they have enough equity on their home, which could last for several years. Another way of removing mortgage insurance is through refinancing. Homebuyers who took an FHA loan consider refinancing with a conventional mortgage once their equity reaches 20 percent so they can remove the PMI.

Lower monthly payments

Best interest rates and no PMI requirement simply means lower monthly mortgage payments for buyers who put a 20 percent down. Using the same mortgage calculator above for a 30-year fixed-rate home worth $300,000, a buyer who was able to take out a mortgage with a 3.6 percent interest rate (or even lower) will only pay a monthly mortgage of around $1,654. When compared with homebuyers who put a 3 percent down, those who chose to put a 20 percent down could save more than $500 each month. It’s a top benefit of putting a 20 percent down, especially for homebuyers who earn an average monthly income of $7,300.

Homebuyers easily build equity

Equity is the value of a home that the owner already owns. It works this way: when taking out a mortgage, the borrower puts a down payment and the lender will fund the amount needed to buy the home. The amount or percentage of the down payment is the equity the owner owns.

Home equity could indeed increase or decline depending on various economic factors. Because of that, there are homebuyers who would think twice of putting a large down payment of at least 20 percent as they would risk their money if an economic crisis takes place again. Some even think that it’s a smart move to save a portion of their funds for an emergency or in another investment instead of putting it all in a home down payment. This could make sense if putting 20 percent down will drain all the borrower’s finances, which could make his or her daily living uncomfortable. Homebuyers who plan to put a 20 percent down payment should assess their finances first and determine if they will still have enough funds left to sustain a comfortable living. 

A drop in the home’s market value should not be a concern for homebuyers who expect to live in the home for the rest of their lives. On the other hand, if the economy continues to get better and home value increases, home equity also appreciates. Over the years, as homeowners dutifully repay their mortgage, their home equity increases. When home equity increases and appreciates, homeowners could use it to borrow funds or buy a new home.

Conclusion

The 20 percent down payment ruling is the minimum amount that lenders generally accept when financing a mortgage. Although homebuyers could put a down payment for as low as 3 percent, lenders will require them to pay PMI to reduce the risk of lending money. Putting a 20 percent down payment has several advantages for homebuyers who have saved enough funds to buy a home. When deciding to put 20 percent down, it’s important for homebuyers to assess their finances first to determine if they can still have a comfortable living after making the purchase.