This is part of an ongoing series in which we answer frequently asked questions among home buyers. Today’s question is: What happens if you put down less than 20% when buying a home?
The short answer is that you will probably have to pay for private mortgage insurance, if you put less than 20% down on a home purchase. There are ways to avoid this added cost, and we will discuss those strategies in a moment. But for now, just know that you might encounter an additional cost in the form of mortgage insurance.
Putting Down Less Than 20% on a Home Purchase
Home buyers are not required to put down 20% when buying a house. This is a common misconception. The truth is you could possibly get a conventional home loan with a down payment as low as 3%. The FHA loan program offers 96.5% financing, with an investment of just 3.5%. Also, there are some credit union programs out there that offer 100% financing.
So you don’t necessarily have to make a down payment of 20% on a home purchase.
With that being said, many home buyers do choose to make a down payment of 20%, and there is a very specific reason for this. They do it to avoid having to pay for mortgage insurance.
The Extra Cost of Mortgage Insurance
When a home loan accounts for more than 80% of the property value, mortgage insurance is typically required. In other words, if the loan-to-value (LTV) ratio rises above 80%, it triggers the insurance requirement. Like it or not, this is just an industry standard.
So if you put less than 20% down on a home purchase, you might have to pay the extra cost of mortgage insurance.
So how much does it cost? On average, private mortgage insurance (PMI) ranges between $40 and $80 per month, for every $100,000 borrowed. For example, on a $200,000 home loan, a PMI policy might cost anywhere from $80 – $160 per month. The cost tends to go up with the size of the home loan.
Everything we just talked about applies to conventional home loans that are not insured by the government. Government-backed mortgage programs, like the popular FHA home loan, can also have this extra insurance. In fact, FHA loans require two kinds of mortgage insurance for home buyers.
- There’s an upfront premium equal to 1.75% of the loan amount.
- There’s also an annual premium that comes to 0.85% of the amount borrowed, for most borrowers.
The bottom line is that if you put less than 20% down on a home purchase, you might trigger the mortgage insurance requirements mentioned above. And that could result in a higher monthly payment, while also increasing the overall cost of your loan.
(You might also end up with a higher rate, as a result of making a smaller investment.)
But mortgage insurance isn’t all bad. Without it, a lot of people simply would not be able to purchase a house. Or they would have to wait a lot longer in order to save up a larger down payment. So PMI is basically a way to extend mortgage financing to a larger number of home buyers, while reducing risk for mortgage lenders and investors. It offers a path to home financing for those who cannot afford a larger down payment.
This article answers the question: What happens if you put less than 20% down on a home purchase? If you would like to learn more about this topic, follow the hyperlinks spread throughout the article. Our website offers hundreds of articles and tutorials for homebuyers, and many of them have to do with down payments and mortgage insurance.
Disclaimer: Every lending scenario is different, because every borrower is different. So your situation might be different from the examples presented above.
Brandon Cornett is a veteran real estate market analyst, reporter, and creator of the Home Buying Institute. He has been covering the U.S. real estate market for more than 15 years. About the author