3 Problems With Making Less Than a 20% Down Payment on a Home
by Maurie Backman | Updated July 19, 2021 - First published on May 9, 2021
Low on down payment funds? Here's why that could hurt you.
Most conventional mortgage lenders require a minimum down payment of 5% on a home purchase, though many have higher requirements. Some want 10% down. And some lenders may even insist on 20% at closing.
But even if your lender doesn't require a 20% down payment, you may want to push yourself to make one anyway. If you don't, you'll risk these consequences.
1. Private mortgage insurance
If you don't put down 20% on your home, you'll pay extra for it in the form of private mortgage insurance, or PMI. PMI is generally paid on a monthly basis on top of your regular mortgage payment, and it can equal 0.5% to 1% of your loan.
The purpose of PMI is to protect your lender in case you start falling behind on your payments. If you get hit with 1% PMI on a $200,000 mortgage, it means you'll spend an extra $2,000 a year to own your home until you've paid enough money into your mortgage to get your PMI canceled. This happens automatically once your loan balance falls to 78% of your home's value.
2. A long road to build equity
Equity is the portion of your home that you own outright. If your home is worth $250,000 and your mortgage balance is $200,000, it means you have 20% equity in your home -- or $50,000. If you don't make a 20% down payment on your home, it'll take you a longer time to build enough equity to be able to borrow against it.
For example, to take out a home equity loan or HELOC (home equity line of credit), a lender may require you to already have 20% equity in your home. So if you start out with less than a 20% down payment, it could be years before you're able to use your home as a source of cash.
3. You could run into trouble if you need to sell
It's possible that your financial circumstances might change after you sign your mortgage. You could lose your job, get a new job offer that requires you to move, or encounter another situation that requires you to sell your home. But here's the problem -- the less money you put down on your home, the greater your chances of being underwater on your mortgage when the need to sell arises.
When you're underwater on a mortgage, it means that your home's market value isn't high enough to cover your remaining home loan balance. At that point, you may be forced into foreclosure if your lender won't agree to a short sale. A short sale is when your lender agrees to sell your home at a price that's lower than your mortgage balance and write off the difference so you're not liable for it. Either option, however, could hurt your credit score and make it harder for you to buy another home once your circumstances improve.
Putting 20% down on a home may not be possible -- and to be clear, you don't necessarily need to make a 20% down payment. You may have plenty of options for getting a mortgage with less money down. Some of these options may include:
It's also not unusual to buy a house with zero down payment. Just be aware of the repercussions that could ensue if you don't put 20% down, and make sure you're okay with them. Otherwise, you may want to hold off on buying until you're able to bring more money to your closing.
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