The Myth of 20% Down Payment

You may have been told that you should put down 20% to buy a home. This may give you more choices and let you avoid private mortgage insurance, but this large amount may not be prudent, or necessary, in all circumstances. Some experts advise keeping your mortgage down payment small — a strategy that sets you up so you’ll be better assured of liquidity when life happens.

What’s going to happen with the economy? No one can be sure, but it’s pretty certain that the economy and home prices are closely linked. That’s why buyers who make large down payments find themselves overexposed to economic downturns compared with buyers who made small down payments.

Take this scenario: You make a 20% down payment on a home. What you’re really doing is converting $80,000 on a $400,000 house to illiquid home equity. What if, instead, you opt for the Federal Housing Administration mortgage program, with a down payment of just 3.5%? In this situation, that’s only $14,000 down.

Now, if the economy turns for the worse, home values will plummet — in some markets dropping as much as 20%. These buyers’ homes are now worth $320,000 with no home equity yet available. The buyer who made the large down payment finds that the money is lost and can’t be recouped until the housing market recovers. The buyer who put down only $14,000 transferred the risk to the bank. The smaller down payment translates to a smaller risk.

You may say that a large down payment helps you afford more house, but turn that around: Maybe you shouldn’t use your last dollar. You don’t save a ton of money each month by putting down a lot.

And yes, there’s always the PMI issue: When you get a conventional mortgage with a down payment of less than 20%, you have to get private mortgage insurance. However, if you go the FHA route, the agency doesn’t charge more to people with lower credit scores, while PMI does. However, you cannot cancel annual mortgage insurance premiums if you put down less than 10% on an FHA loan.

Ultimately, it’s wise not to deplete your retirement savings account or emergency fund to buy a home. You might need money to make repairs after moving in or run into a financial hardship. You won’t have a cushion to fall back on.

Besides, if you take advantage of down payment assistance programs that provide grants or loans, you can buy a home with only 3% down. And research shows that millennials tend to go with lower down payments than older generations did.

What this tells us is that the 20% down payment is no longer the standard: Down payment assistance programs are available. The 20% down payment myth is dispelling, opening the path to homeownership to younger generations.

The bottom line? Don’t make assumptions and get professional financial advice before choosing a mortgage and making a down payment decision.