Investing

Should You Put Down Less Than 20 Percent on a Home?

For decades, the standard advice for prospective homeowners has remained the same: Make a down payment of at least 20 percent.

And it’s good advice. Putting down a substantial deposit gives mortgage lenders confidence that you can afford to pay them back, which could lead to a faster approval, lower monthly payment and better interest rate. It also means you can avoid shelling out for private mortgage insurance (PMI), which could cost more than 1 percent of the entire loan every year. (Generally, you can stop paying it once you’ve hit the 20-percent threshold, but that’s not always the case.)

Yet despite these benefits, the majority of buyers don’t put down 20 percent. According to the National Association of Realtors, first-time homebuyers who financed a mortgage in 2016 put down just 4 percent, while repeat buyers put down 16 percent. So what gives?

For one, 20 percent can be a lot of money to come up with—especially when you consider that most Americans don’t even have enough saved to cover unexpected expenses. And the average price of a new home in October 2017 was more than $400,000, according to the U.S. census, which translates to a hefty $80,000 down payment by those rules. (Houses being resold are typically less.)

That may help explain why alternative loan options with ultra-low down payment requirements are big draws, says mortgage advisor Casey Fleming, author of “The Loan Guide: How to Get the Best Possible Mortgage.” For example, FHA loans—or mortgages insured by the Federal Housing Authority—allow qualified buyers to put down just 3.5 percent. With a conventional loan (sometimes called conforming loans), which is the most popular type of loan financing, you can put down as little as 3 percent. Other loans, like those for qualified veterans and residents of rural areas who meet certain U.S. Department of Agriculture requirements, actually let buyers put down nothing, Fleming adds.

These options may be particularly attractive if you live in an area where it’s become cheaper to buy than rent, or if you’re worried that rising home prices (or mortgage rates) may mean you’ll pay more for a home down the road if you wait. But there are drawbacks to going this route.

“Smaller down payments increase your mortgage costs, add PMI costs and increase the risk you'll end up underwater (meaning you owe more than your home is worth if it falls in value),” says Greg McBride, the chief financial analyst of Bankrate. FHA loans, for example, typically have higher fees and insurance costs than conventional loans.

Ultimately, putting at least 20 percent down is still the way to go, if you can do it. But regardless of how much you end up putting down, one thing’s for sure: You don’t want to completely wipe out your savings buying one. Put down an amount that leaves enough to cover moving expenses and closing costs while not depleting your emergency fund, McBride says. Between lender, appraisal and government fees, plus the cost of title work and property insurance, you might need $10,000 or more just to cover closing costs.

Budgeting for all the associated costs of homeownership, and maintaining a stocked emergency fund, can also help keep you on solid financial footing long after you hand over your down payment.

Related: What You Should Know Before You Buy Your First Home

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