You’re faced with plenty of decisions when buying a home. Two bedrooms or three? This neighborhood or that? A big yard or no yard at all?
Yet here’s one of the most important questions of all: “Should I make a 20% down payment?”
And our answer is, “It depends.” As in, you should consider a number of factors.
One thing is for sure: The days of most mortgage lenders requiring a 20% down payment are long gone. Many mortgage products and programs today allow you to purchase a home with a much smaller down payment.
If you’re weighing your options, Peter McCarthy, PNC Bank’s Head of Mortgage, offers that a 20% down payment on a home can pay off over the long term.
“A lot depends on your circumstances. But if you can make that 20% down payment work, you could enjoy all kinds of benefits, sometimes in unexpected ways.”
And what benefits are those? We’re here to give you guidance.
No Private Mortgage Insurance
Mortgage lenders once had a rule of thumb that the dollar amount of a mortgage couldn’t exceed 80% of the home’s actual market value. The remaining 20% used to be where the homebuyer’s down payment came into play.
So, in that example, the 20% difference between the mortgage amount and the actual purchase is known as equity. Over time, the more your home increases in value and the more your mortgage principal decreases, the greater your equity becomes.
How to Calculate Home Equity | PNC Insights
Homebuyers who cannot make the 20% down payment are required to pay for Private Mortgage Insurance (or PMI) for both conventional and FHA mortgages (Jumbo loans do not require PMI). Billed along with your regular mortgage payment, PMI is designed to protect the lender against default. PMI can only be canceled once your equity passes that critical 20% threshold.1
According to McCarthy, “The cost of paying PMI really adds up over time. So, if you can manage to put 20% down on a home purchase, you could potentially save thousands of dollars a year. That’s money you can commit to other things.”
While a 20% down payment could eliminate a major monthly expense, there are other benefits as well.
Lower Interest Rates
Another lending term to know is Loan-To-Value ratio or LTV. Simply put, LTV is the amount of the loan compared to the value of the home. Typically, the lower the LTV the more likely you’ll get a small break on your interest rate.2
“You want to have the lowest mortgage payment possible,” McCarthy adds. “While a 20% down payment eliminates PMI, it could also shave a little off your interest rate, too. Every little bit helps your monthly household budget. What’s more, even a small reduction in rate can save you thousands of dollars over the duration of your loan.”
Home Loans: Home Lending Options & Current Rates (pnc.com)
The Intangibles Matter, Too
Housing inventory is tight. That means sellers now often enjoy multiple offers. In turn, this makes it crucial for buyers like you to prove that you can readily be approved for financing—or, even better, that you’re ready to purchase in a hurry with a pre-approved mortgage. Although any number of other factors are considered—such as the type of property being purchased, your FICO score, and your reserves—having a 20% down payment bolsters your odds of approval by a lender.3
“Over the past several years, we’ve seen a big shift in terms of who has the advantage when it comes to buying and selling a home,” McCarthy remarks. “Gone are the days when most buyers could strike a deal with the seller and then wait on approval from the lender. Today, in many markets, it’s crucial that you have the financing already lined up. And being able to muster a 20% down payment makes it far easier for most lenders to say ‘Yes.’”
But, Sometimes, Smaller Is Better
There are plenty of occasions when that 20% down payment makes financial sense. But that doesn’t mean that it’s the right option for every homebuyer. After all, buying a home is only one part of your overall financial picture.
Especially if you are just starting out in life, it could take years to save up for a big down payment. Depending on your current situation, you may prefer to begin growing equity right away or enjoy the tax deductions provided by a mortgage. Or you may just want the lifestyle benefits of living in a home of your own. If so, there are plenty of mortgage options where a much smaller down payment will do.
What’s more, there’s also the question of cash flow. If you spend all your money on a down payment, will you have enough left over for other things?
“Moving is expensive,” McCarthy continues. “So are furnishings and all the other things that go into making a new home feel like home. And don’t forget that it’s important to leave yourself a considerable reserve fund. Because if you move into a new home, the last thing you want to do is accrue other kinds of debt because all your cash went to the down payment.”
With all the pros and cons when it comes to deciding on a down payment amount, McCarthy has one final piece of advice: Talk to a professional face to face.
“No two people have the exact same financial picture or goals. If you’re thinking of buying a home, a mortgage loan officer will be able to guide you through all the possible choices and programs. Together, you can look at your total financial picture and map out a strategy. And—who knows?—you might be able to get into that home sooner than you expect.”
