Real estate transactions have changed in the last few decades. Not only has the process of real estate sales changed but so has the process of acquiring a loan. Many aspiring homeowners think that they have to lay down 20% cash in order to qualify for their home. This is largely a myth (and there’s an interesting reason behind that myth), but the numbers are complicated and they vary.
So how much is a good down payment? The short answer is, it depends. For the long answer, keep reading.
The Creation of the 20% Myth and Down Payments Work Today
Once upon a time, a 20% down payment was the expected cash upfront. In the early 1950s, when people stopped making interest payments on their mortgage, the banks acted quickly to acquire the home and put it back on the market. Everybody knows banks don’t want to be in the real estate business, so they would offer steep 20% discounts on these foreclosures to wipe their hands clean of the non-producing assets they largely saw as a nuisance. So, somehow, the 20% became the norm.
The Federal Housing Administration was created in the 1930s to back mortgages, but it also required the 20% down. Up until this point around 1956, banks would not approve a mortgage loan unless there was a payment of 20% upfront. That big chunk of cash served as the bank’s insurance policy if the homeowner defaulted on their loan. It made it a high-stakes game for any homeowner—if they stopped payments, they would not only lose the house but also the 20%.
Most early home mortgages were short-term loans. People would buy a home for $30,000 and 20% down. This meant the loan was paid off quickly. In fact, the 30 year-fixed-rate was not a reality until after WWII and the Department of Veterans Affairs adopted it, and it eventually became the norm. It was also a result of rising home prices, which changed the real estate game.
For many homeowners, 20% is still the average down payment. For certain types of loans or buyer scenarios, 20% is the required amount. For example, for investment properties, buyers have to cough up that extra down payment and reach the 20%.
So When and How Did The 20% Rule Change?
As home prices surged, the banks realized that the 20% down payment requirement shut out a big chunk of the population from affording homes, but in order to make mortgage loans acceptable with a lower down payment, there had to be a way for the banks to protect themselves. And voila, the Private Mortgage Insurance (PMI) industry was birthed.
What is PMI?
Private Mortgage Insurance provides a little insurance policy for lenders that gives less than 20% of downpayment. That means the borrower pays a little extra each month as insurance to the bank, in case the lender defaults. For banks, this provided more lending opportunities and shifted the onus of the extra payment onto the homeowner.
The implementation of PMI increased homeownership rates in the United States. According to Mortgage Reports, by 1971, PMI was available to homeowners that had only about 5% downpayment and pushed homeownership rates up to 64.5%.
What Is a Good Down Payment For Me?
So now that we’ve covered a little bit of background and gone over the implications of PMI, here’s what you need to consider when thinking about your own down payment. The downpayment ultimately affects the amount a lender will consider giving you, the terms and conditions of the loan, and the kind of mortgage you qualify for.
- What type of loan are you applying for? Every loan has different implications and varies slightly in its terms. Make sure your mortgage lender explains the meaning and details of the loans available to you based on your situation and what the terms mean.
- Your credit score may come into play. FHA loans, for example, require a minimum of 3.5% for credit scores of 580. A homeowner’s credit score between 570-500, FHA requires 10% down.
- Consider your monthly housing budget. The bigger the down payment, the less your monthly payment. So, for example, if you have a good chunk of savings in the bank but don’t have a high monthly income, a larger down payment might make sense.
- Consider raising your credit score or working on your income-t0-debt ratio. If you’re considering purchasing a home in the next few years, focusing on building good credit and lowering other debt is a great way to access mortgage loans that may not require such high down payments.
Recent Changes During COVID-19
The pandemic impacted the way banks lend to homeowners due to the rise in possible defaults and forbearance. Banks are being particularly meticulous when it comes to checking and rechecking employment documentation and income verification is current up to the last second.
Get a Mortgage Lender that Works Out What’s Best for You
If you’re ready to buy a home, don’t fall for the 20% myth. Many people have become homeowners with much less than that. According to the National Association of Realtors, about 72% of people purchase a home with less than 20 percent.
While the amount of down payment can vary, it depends on certain factors. Working with your mortgage lender can help you decide what might be the best way to go for your circumstances. Call Rocky Mountain Mortgage Company today and find out more!
