Down Payments: Which Amount is Best?

For many first time home buyers a critical question in their home search will inevitably become “how much should I put down?”. Many buyers are conditioned to think that a 20% down payment is a requirement and end up leaving all other options unexplored.

Sure, a 20% down payment is typically considered the ‘gold standard’ and virtually all lenders will use it to quote or estimate mortgage rates. However, the truth is that a down payment below 20% may actually be a better financial decision for you and (with few exceptions) will not hurt your chances of winning a potential bidding war. In fact, the average down payment for all first time home buyers in the US is only 7%!

The Basics

A down payment is the amount that you are responsible for paying up-front when purchasing a home. It is combined with your loan to cover the entire price of the home you are buying, which will all eventually be paid to the seller.

Generally, a higher down payment comes with several advantages:

  1. Easier budgeting, lower monthly payment, reduced risk of default
  2. Reduced debt (less money to pay over the life of the loan)
  3. Lower interest rate (banks are more likely to give favorable interest rates if the total loan is lower)
  4. No private mortgage insurance requirement (PMI is typically required for down payments under 20%)

As a result, with a higher down payment you can afford a more expensive home for the same monthly amount as a less expensive home with a lower down payment. Consider the table below, which shows how the monthly payments for a $400,000 home can end up being equal to a $300,000 when 20% is put down instead of 3%:

On the other hand, down payments below 20% allow first time home buyers a few advantages of their own, assuming the monthly payments can be afforded:

  1. Faster entry into the housing market (no need to wait as long to save!)
  2. A more strategic approach to investments or savings (by putting less down, you can invest the extra money elsewhere and perhaps earn a greater ROI, or plan to use the extra money for a different large purchase)

Buyers with low savings and steady income should not have to feel priced out of most markets or forced to save for years for a 20% down payment. There are many perfectly viable lending options below a 20% down payment.

Also, keep in mind that a common strategy after making a smaller down payment is to refinance your mortgage some time later when you have more savings or equity built up. At that point, you may be able to lower your interest rate and/or eliminate the required PMI from your monthly housing bill.

Will a smaller down payment hurt my chances of winning an offer? 

To be fair, the short answer to the question is ‘maybe’. However, a low down payment decreasing the chances of your offer being accepted is only partially true in some very specific housing markets or bidding wars. 

The idea is that in very expensive housing markets, a lower down payment signals to the seller that the buyer may not have adequate funds to comfortably afford the home (as well as any unexpected expenses or fees) and therefore may not be worth the time to accept the buyer’s offer. Keep in mind that any delays during the sale process cost the seller more and more each day. In other words, with a small down payment there is some implied risk that the buyer may not be able to secure the loan needed to close successfully, or perhaps the buyer may be scared off by an unexpected fee or repair that turns up in the closing process. This is prevalent in housing markets like San Francisco - one of the most expensive and competitive in the country. The chart below shows the overwhelming majority of down payments are in the 20-30% range. 

Contrast that with the chart below, taken from the greater Seattle area, which is still a fairly high cost and competitive market, but shows very clearly that most down payments end up coming in below 20% - many in the 0-10% range!

What’s right for me? 

To summarize, the best down payment amount is ultimately dependent on a couple of factors:

Your financial situation:

  • If you lack the savings for a higher down payment (or would prefer to invest your savings elsewhere) and can tolerate a slightly higher monthly payment, a down payment under 20% may be the right option for you.
  • If your current savings aligns with your housing goals and you would prefer the comfort of a lower monthly payment and higher equity, a 20% down payment is for you.

Your local real estate market:

  • Unless you are searching in a very high cost and competitive market, it is very unlikely that the amount you are putting down will have an impact of your success when making an offer. However, it is always important to know the ins and outs of each market you are considering.

If you are not sure which down payment strategy is best in your market, sign up below and one of your real estate experts would be happy to help build custom analysis like the one used in this article just for you!

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