How Down Payments Affect Mortgage: 20% Down Payment

A 20% down payment on a mortgage has long been considered a wise financial move. However, it is not mandatory, and homebuyers can secure a home with as little as 3% or even no down payment. A larger down payment reduces the loan amount and monthly payments, and also helps avoid private mortgage insurance (PMI), which is required if the down payment is less than 20%. PMI costs can add up to thousands of dollars over the life of the loan. On the other hand, a smaller down payment can help fast-track homeownership and take advantage of low mortgage rates.

Lower monthly payments

A 20% down payment on a mortgage has long been considered a wise financial move. It helps borrowers avoid paying private mortgage insurance (PMI) on a conventional loan, which can cost up to $70 in monthly PMI costs for every $100,000 borrowed. It also reduces the loan amount, resulting in lower monthly payments. Additionally, a larger down payment puts borrowers in a better position to negotiate a more favourable mortgage rate with their lender, potentially saving them thousands of dollars over the life of the loan.

However, it's important to note that a 20% down payment may not always be feasible or advisable for everyone. In today's economy, with high interest rates and inflation, a smaller down payment can help fast-track the goal of homeownership. A lower down payment means becoming a homeowner sooner, but it also means higher monthly mortgage payments. For instance, a 3% down payment on a $600,000 home would require $18,000, whereas a 20% down payment on the same property would cost $120,000.

There are alternative paths to homeownership for those who cannot afford a 20% down payment. Government-backed loans, such as VA loans for veterans and USDA loans for rural and suburban areas, often require no down payment. Additionally, some lenders offer jumbo mortgages with down payments as low as 5%, and conventional loans can be obtained with as little as 3% down. The National Association of Realtors reported in 2024 that the median down payment for first-time homebuyers was 9%.

For those who already own a home and are struggling with high monthly mortgage payments, there are strategies to reduce these costs. One option is to refinance the home loan, which involves replacing the existing loan with a new mortgage with a lower interest rate or a longer-term, such as refinancing a 15-year mortgage to a 30-year mortgage. Another strategy is to recast the home loan, which allows borrowers to make a large lump-sum payment towards their principal and negotiate a new payment schedule with a lower balance while keeping the same term and rate.

Avoid private mortgage insurance

Private mortgage insurance (PMI) is a type of insurance that is usually required by lenders when the buyer cannot put down at least 20% of the home's price upfront. It protects the lender in case the borrower defaults on the loan. PMI is typically added to the borrower's monthly mortgage payment and can significantly increase the overall cost of the loan.

Make a 20% Down Payment

The most straightforward way to avoid PMI is to make a down payment of at least 20%. This reduces the risk for the lender, and as a result, they will not require you to have mortgage insurance on a conventional loan.

Lender-Paid Mortgage Insurance (LPMI)

In the case of LPMI, the lender covers your mortgage insurance, so you don't have to pay out of pocket. However, lenders usually charge a higher interest rate on the mortgage in exchange for this.

Special Loans for First-Time Home Buyers

Some lenders offer special loans designed specifically for first-time home buyers that do not require PMI. These can be a great option for those looking to avoid PMI without making a large down payment.

Piggyback Loan

A piggyback loan, also known as a "piggyback mortgage," is a strategy that uses two mortgages to avoid PMI. One loan covers 80% of the home's price, and the other loan covers a 10% down payment, resulting in a 90% loan-to-value ratio. This option allows you to avoid PMI while only needing a 10% down payment.

Government-Backed Loans

Certain types of government-backed loan programs, such as VA loans for veterans and service members, and USDA loans for rural and suburban areas, do not require a down payment or ongoing mortgage insurance. However, they may have other requirements, such as income eligibility, and may come with their own set of fees.

Low-Down-Payment Conventional Loan or Government-Backed Mortgage

If you're looking to keep your down payment small, consider a low-down-payment conventional loan or a government-backed mortgage. While you may still need to pay PMI, you can explore options with lower down payment requirements, such as the ones mentioned above.

Remember, the best option for you will depend on your financial situation and goals. Be sure to research and compare the various mortgage products and their requirements to make an informed decision.

Reduced interest rates

A 20% down payment on a mortgage is ideal as it helps you avoid paying private mortgage insurance (PMI). PMI is an additional cost designed to protect the lender in case you default on your loan. It typically costs 0.5% to 1.5% of your loan amount per year and is required if your down payment is less than 20%eliminate this cost and reduce your monthly mortgage payments.

Additionally, a 20% down payment can lead to a more favourable mortgage interest rate. With a larger down payment, you are assuming more of the financial risk, which makes you a less risky borrower in the eyes of lenders. This improved risk profile may put you in a better position to negotiate a lower interest rate with your lender. A lower interest rate can result in significant savings over the life of the loan.

It is worth noting that the decision to put down 20% should be carefully considered within the context of your financial situation. While it can provide benefits, it may not be in your best interest if it compromises your financial stability or depletes your savings. There are alternative options available, such as low-down-payment conventional loans or government-backed mortgages, that can help you become a homeowner sooner while preserving your financial cushion.

To make an informed decision, it is recommended to consult with a mortgage advisor or housing counsellor. They can help you explore all your down payment options, understand the associated risks and benefits, and determine the best course of action based on your financial circumstances and homeownership goals.

Furthermore, it is important to be aware of additional strategies to reduce your mortgage interest rate. One option is to purchase discount points, which are essentially prepaid interest that lowers your interest rate. Each point typically costs 1% of the loan amount and reduces the interest rate by 0.25%. Another option is to explore refinancing programs, such as those offered by Freddie Mac and Fannie Mae, which can guarantee an interest rate reduction of at least 0.50%.

Smaller down payments

While a 20% down payment is ideal, it is not always necessary. Many homebuyers are able to secure a home with a smaller down payment of 10%, 3%, or even 0%. The down payment amount depends on various factors, including the loan type, financial situation, and property type.

A smaller down payment can help you become a homeowner sooner, but it also means larger monthly mortgage payments. It is important to consider your financial situation and future goals when deciding on a down payment amount. For example, do you have an emergency fund, how much debt do you have, and are you close to retirement?

If you put down less than 20% on a conventional mortgage, you may need to pay for private mortgage insurance (PMI). PMI protects lenders on mortgages with high loan-to-value ratios and is added to the borrower's monthly mortgage payment. Once you reach 20% equity, you can request that your lender removes the PMI.

There are several loan options available that do not require a 20% down payment. Conventional mortgage borrowers buying a primary residence can often obtain a mortgage with as little as 3% down. Government-backed mortgages, such as VA and USDA loans, may not require any down payment at all. Jumbo loans, for amounts exceeding conforming loan limits, typically require a minimum of 5% down payment.

It is important to note that a larger down payment can lead to a lower interest rate, as it reduces the financial risk for the lender. However, it is not the only factor considered when determining the interest rate. Other factors include the loan-to-value ratio, repayment term, and economic conditions.

Alternative down payment programs

While a 20% down payment is ideal as it helps avoid private mortgage insurance (PMI), reduces the loan amount, and lowers monthly payments, it is not a requirement for purchasing a home. Many homebuyers are able to secure a home with as little as 3% or even no down payment at all.

If you are unable to make a 20% down payment, there are alternative down payment programs that can help bridge the gap. These programs are typically reserved for first-time homebuyers or buyers with lower to moderate incomes for their area. Many down payment assistance programs are available through state housing finance agencies, major cities, nonprofits, and even mortgage lenders.

• Government-backed loans: Certain types of government-backed loan programs, such as VA loans and USDA loans, do not require any down payment. VA loans are available to veterans and service members, while USDA loans are for rural and suburban areas as long as the borrower meets income and eligibility requirements.
• Low-down-payment conventional loans: Conventional mortgage borrowers buying a home they plan to use as their primary residence can often get a mortgage with as little as 3% down.
• Down payment assistance programs: These programs provide grants or loans to help cover the down payment and closing costs. Grants are the most valuable form of assistance as they are considered a gift and do not need to be repaid. Some examples of down payment assistance programs include the Illinois Housing Development Authority (IHDA) Access Mortgage Program and California's MyHome Assistance Program.
• Monetary gifts: In some cases, a monetary gift from family members or your employer can comprise a portion or all of your mortgage down payment.

Frequently asked questions