First-Time Home Buyers Typically Put 6% Down. Here's Why That's a Problem

It's understandable, but it can be risky and expensive.

If you're currently a renter but long to buy a place to call your own, chances are, it's needing to have a down payment that's tripping you up the most in the process. When you sign a lease for a new rental situation, you're likely to only be on the hook for a deposit equaling a month of rent, as well as possibly a cleaning or pet deposit. A down payment to secure a mortgage loan is going to amount to much more than that, especially when you consider that Q3 2022's median home price in the U.S. was $454,900, per the Federal Reserve Bank of St. Louis.

If you happen to be buying a home for just that price, using an FHA mortgage loan and making the minimum required down payment of 3.5%, you'd be looking at a down payment of nearly $16,000. For a 20% down payment, the figure is almost $91,000. Depending on your salary and circumstances, it could take you years to save that 3.5%, let alone 20%.

According to the 2022 Profile of Home Buyers and Sellers by the National Association of Realtors (NAR), first-time home buyers made an average down payment of just 6% on their home purchase. This isn't ideal, for a few key reasons.

RELATED: The Definitive Guide for First-Time Home Buyers

Mortgage insurance adds to your payments

It is a myth that you must make a 20% down payment to secure a mortgage loan, but it's a myth with a basis in fact. That fact is that if you make a smaller down payment on a home you're purchasing with a conventional mortgage loan, you'll have to pay private mortgage insurance (PMI) until your loan balance falls below 80% of the home's value. While lenders used to require a 20% down payment, now you can buy using a conventional loan with a down payment as small as 3%, depending on your credit score.

If you're buying with an FHA loan (which is guaranteed by the Federal Housing Administration), your down payment requirement is 3.5% if your FICO Score is at least 580 (or 10% if it's between 500 and 580). With these loans, if you put down less than 10%, you'll pay mortgage insurance premiums (MIP) for the life of the loan (with a 10% down payment, it's 11 years).

So while you may be able to secure a home loan with a down payment under 20%, you will end up paying more every month in the form of those mortgage insurance payments. Mortgage insurance is a protection for your lender in case you default on your loan. When you borrow more than 80% of the value of the home, the lender is taking on that risk, and mortgage insurance helps mitigate it. Ultimately, you'll be looking at paying a percentage (often 0.5% to 1%) of the loan amount every month. On the $454,900 home mentioned above, that's an extra $2,274.50 to $4,549 per year, or $189.54 to $379.08 per month, on top of your mortgage payment. That's not a small amount of money.

You could end up underwater on your home

If you go into a home purchase with less money down, and property values take a hit, you could end up underwater on your mortgage. This is when you owe more on the mortgage loan than what the home is worth. On its face, this isn't a problem if you can still afford your payments and aren't intending to sell the home.

But if you lose your job and find yourself in the position of needing to get out from under the loan, you could be in trouble if you can't sell for at least as much as you owe (not to mention that you'll have to cover closing costs and pay real estate agents' commissions). This isn't ideal.

Try to put as much down as you can

If a 20% down payment is so far out of reach for you that it seems impossible, I certainly sympathize. And ultimately, if you want to become a homeowner, and are otherwise ready to do so (meaning your finances are in good shape and you have reckoned with all the expenses that go into homeownership), you can certainly buy with a smaller down payment. Just be aware of the extra costs you'll need to pay in the form of mortgage insurance, and know that you'll be taking a risk of ending up underwater.