Here's What Happens When You Make a Small Down Payment on a House

Buying a house is an expensive financial commitment. You'll likely need to get a mortgage lender to provide most of the funds necessary to purchase the property. And most mortgage lenders require you to make a down payment of some amount.

Ideally, you will put down around 20% of the value of the home you are buying. But that's not reality for many people. In fact, the National Association of Realtors indicates the typical first-time buyer consistently puts down around 6% to 7%. And some lenders allow even less -- as little as 3% in certain cases.

If you are thinking about making a small down payment, here's what you need to know about the consequences of that choice.

You will have to pay for mortgage insurance

If you put down less than 20% on a home, you are considered a higher risk to a mortgage lender. The lender wants to make sure that if you stop paying and it has to foreclose, it can get back the money it lent to you. If you make a small down payment, lenders worry they won't be able to recover all you owe plus their costs.

As a result, lenders generally require you to pay for private mortgage insurance (PMI) when you make a down payment below 20%. PMI typically costs anywhere between 0.5% and 1.5% of the loan amount annually. The median sale price of a home in the first quarter of 2023 was $436,800. If you put 10% down, borrowed the remaining $393,120, and paid PMI at a rate of 1.5%, you'd be looking at $5,896.80 per year in PMI costs. That adds $491.40 to your monthly mortgage payment.

To be clear, this insurance doesn't protect you if you stop making payments. It just ensures your lender recovers its funds. You'd still lose your house, but you're stuck paying almost $500 per month for this if you don't have a 20% down payment.

You may find it harder to find a lender or get stuck with a loan at a higher rate

Even with PMI, you're still considered a higher risk if you buy a home with a small down payment. As a result, you'll generally be offered a loan at a higher rate than someone who is putting more money down.

If you're making a very small down payment -- below about 5% or 10%, then you may also have a much more limited choice of who to get a loan from, as not all mortgage lenders will allow you to borrow in this situation.

When you have a larger down payment, you can shop around with more lenders and hopefully get a better rate and a more affordable loan.

You could have problems if you want to refinance or sell

Finally, the last big issue you could face is that a small down payment could create issues if you want to refinance or sell your house.

To sell, you'd need to make enough money to pay off your mortgage in full plus cover all closing costs -- which could include a 6% real estate agent's commission. If you didn't put much money down, you might fall short. Say you put just 3% down. Unless property values had increased substantially, you wouldn't have enough money to cover closing costs plus pay off the remaining amount you owed.

You could run into the same trouble when refinancing, especially if property values declined since you purchased -- you might not be able to meet your lender's loan-to-value requirements since lenders aren't going to give you a loan for more than your home is worth.

Ultimately, there are big risks to making a small down payment, so be sure to consider these downsides before you put down less than 20% on a home you're buying.