This is a critical question — especially for those who haven’t yet saved up enough for a 20% down payment, and for those who are not sure they want to put their entire savings into buying a home.
It becomes especially important when the home you want is priced so that the monthly payment is outside of your budget. If you want an extra bedroom for your growing family or if you want a home located closer to your work — or even if you just want a nicer home, you may be tempted to stretch your monthly housing budget a little farther. How much you put down on the home can have a dramatic effect on your ability to make that payment.
To examine this in more detail we’ll compare making a 20% down payment with making a 10% down payment and think about which might be appropriate in different circumstances.
What it Means to Make a 20% or 10% Down Payment
First, let’s get our terminology straight. A “down payment” refers to the money you pay upfront to purchase a home.
Making a 20% down payment typically allows you to get better loan terms from your mortgage lender. If you were buying a $400,000 house, you would put down $80,000 (20% of $400,000) towards the purchase. The lender would lend you the other 80%, or $320,000. In many cases, loan programs that allow a smaller down payment are available, but the terms of the loan may be less favorable.
Going back to our example above, let’s say you want to buy a home that costs $400,000, but you only have 10%, or $40,000, available for a down payment. In that case, you will need to borrow 90%, or $360,000.
Getting Approved with a 20% or 10% Down Payment
Whether your down payment is 10% or 20%, you will need to be approved for the loan. To approve your loan, lenders want to make sure that you will make your monthly loan payments on time and are not likely to default on your loan at any point in the future.
To determine your likelihood to pay, lenders will look at your credit history. For example, do you pay your credit card bills on time? They will also look at your income, the amount of money you have available for a down payment and for reserves, and other debt obligations you may have. Using this information, they will determine whether or not your income is sufficient to support the total monthly housing payment, which includes the principal and interest on the loan as well as the property taxes and property insurance. Calculating your “debt-to-income” ratio is a key component of the lender’s decision. The smaller the monthly payment, the lower the debt-to-income ratio and the more likely you are to qualify for the mortgage loan you need.
Here’s how the size of your down payment can make it easier to get approved:
- If you can put down 20%, you can avoid paying a significant mortgage insurance premium, which keeps your total monthly payment low and makes it easier to qualify.
- A larger down payment also increases your personal stake in the home. Lenders interpret a larger personal stake as decreasing the likelihood that you may default on the loan at some point in the future.
For these reasons, the amount you have available to put down can have a major influence on whether or not you get approved by your lender and how much home you can afford.
Why Make a 20% Down Payment?
Ultimately, your unique circumstances will help you determine what is right for you. But let’s look at a few common reasons to make a 20% down payment:
- You have enough saved up to comfortably put 20% down
- You don’t need to use that money for any other purpose
- You want a lower monthly payment
- With only 10% down your income will not support the loan you need
For those who have enough saved, a 20% down payment is generally a good thing. Not only does it give you more equity in your home, but it also lowers your monthly mortgage payments for the life of the loan and helps you avoid paying mortgage insurance. It can also help you income-qualify for the loan in the first place.
Mortgage Insurance and Your Down Payment
Let’s take a closer look at the impact of mortgage insurance, because it can add a lot to your monthly payment. Mortgage insurance (MI) is almost always required by lenders when the down payment is less than 20% because a loan with a low down payment is riskier and the insurance protects the lender if the home buyer defaults.
To see how this works, we can return to our example above. Assuming you buy a $400,000 home, here are estimated monthly payments with 10% and 20% down payments:
- With 10% down, the estimated total monthly housing payment is $1,941 (this includes a mortgage insurance premium of $222).
- With 20% down, the estimated total monthly housing payment is $1,528.
(These estimated payments assume a 4% fully amortizing 30-year fixed rate loan, an annual mortgage insurance premium of 0.74% of the initial loan amount, annual property taxes equal to 1.25% of home purchase price, and annual property insurance equal to 0.3% of the initial loan amount.)
In this example, putting down 20% lowers your monthly payment by $413! That’s quite a difference. For many families, saving $413 per month is the difference between feeling squeezed financially and feeling like you can live comfortably without worry.
That’s why many people prefer to put 20% down. While the exact numbers will be different in your particular situation, the bottom line is that you can lock in a lower monthly payment, and if you want to avoid paying mortgage insurance, you will almost certainly need a 20% down payment.
Why Make a 10% Down Payment?
Now let’s consider when it might make sense to make a 10% down payment.
The most common reason for making a 10% down payment is that maybe it is the only way for you to get the home you want, at the time you want. In other words, if you have $40,000 in your savings account and you want to buy a home for $400,000 right now, your only solution is to put down 10% and get a loan for $360,000. You simply don’t have the $80,000 required for a 20% down payment. In that case, your monthly mortgage payment would be higher, as shown above.
Another common situation where people decide to make a 10% down payment is when they wish to set aside a portion of their cash for things like emergency funds, remodeling their house, or other investments. Let’s say you have children and want to use some of your money to add a new bedroom to your new home. Or perhaps you want to invest that money into a college savings fund. Or maybe you just want to have a large emergency fund to protect your family. In this case, you have the money required for a 20% down payment, but you aren’t willing to use all of it. By putting down only 10%, your monthly mortgage payment would be higher, and you would have to live with the higher monthly payment.
But now there is a program available to help people in these situations. Unison is a home ownership investment company that partners with home buyers to contribute up to half of the down payment in return for a share of the appreciation or depreciation in the home. If you have 10% to put down, Unison will match it to produce a 20% down payment. This allows you to get the benefits of making a 20% down payment. (Click here to learn more about Unison)
Take a close look at all your options. You may decide that a 10% down payment is the right option for you. If you want to set money aside for closing costs and home repairs, and you don’t want to pay mortgage insurance, then a home ownership investment from a company like Unison might be a good fit for you.
Regardless of whether you end up making a 20% down payment, or a smaller down payment, it’s always a good idea to understand the risks and benefits associated with your decision. Exploring all your options is the key.
No matter what you choose, we wish you luck as you search for your new home!