Myths Surrounding the 20% Down Payment in Home Buying: Debunking Common Myths and Strategies

Is it absolutely necessary to put 20% down when buying a home? The answer is no, and in this article, we will explore why this concept has gained traction and how it can be misleading.

Contradicting the Praiseworthy 20% Myth

There is a widespread belief that putting down 20% is mandatory for several reasons, which we will now dispel:

Lenders Are Very Cautious with Their Approvals

Contrary to popular belief, most loans are now processed through Automated Underwriting Systems (AUS). These systems, such as Desktop Underwriter (DU) and Loan Prospector (LP), automatically approve loans based on the provided data. Fannie Mae and Freddie Mac set the minimum credit standards at a score of 620, and if the AUS returns an approval and the documentation supports this, the loan underwriter will almost always approve it.

Getting a Mortgage Is Impossibly Difficult

The mortgage process has certainly become more stringent, especially over the past two decades. However, for most people, it is a routine process, especially if they can furnish the necessary documentation. This is mandated by the Dodd-Frank Act as the “Ability to Repay” (ATR) rules, which require proof of income and assets to demonstrate the ability to repay the loan.

20% Down Payment Is the Industry Standard

According to a recent study by the National Association of Realtors (NAR), only 60% of home buyers make a down payment of 6% or less, and 54% make down payments of less than 20%. Lenders are acutely aware of risks and use “risk-based pricing,” adjusting interest rates according to the loan-to-value ratio and the borrower's credit score.

Understanding Down Payments and Mortgage Insurance

While a higher down payment can reduce the total amount borrowed and eliminate the need for mortgage insurance, it is not a prerequisite for home ownership. Instead, mortgage insurance is a substitute for a larger down payment. It exists to manage the lender's risk, especially when the buyer's down payment is less than 20%.

Mortgage Insurance Costs and Benefits

For example, a buyer with a score of 760 or higher would pay 0.30 for mortgage insurance on a 90% loan, while a buyer with a 620 score would pay 1.10. The monthly payment for a 360,000 loan at 90% would be $90 for a high-scoring borrower and $330 for a minimally-qualified borrower. However, once the loan balance is 80% of the home's market value, the lender will allow the mortgage insurance to be dropped, usually within 30 months if the property value appreciates at a rate of 3% per year.

Alternative Solutions: Single Premium Mortgage Insurance

Another option is to pay a single premium for mortgage insurance, which can be added to the loan balance. A buyer with a higher credit score (760) would pay 1.2% of the loan balance at closing. For a 360,000 loan at 90% that would amount to $4,320.

Conclusion

Putting 20% down is not a mandatory requirement for buying a home. It is a strategy that can significantly reduce the cost of homeownership, but it is not the only way to achieve this. Understanding the nuances of down payments and mortgage insurance can help buyers make more informed decisions and find the best path to homeownership that fits their financial situation. When pursuing a mortgage, it is crucial to prioritize what works best for you and to recognize that 20% is just one option among many.