There was a time when it was virtually inconceivable to get a mortgage without at least a 20 percent down payment. Then lenders started to take more risks and suddenly people were able to get mortgages without putting any money down, or with only a small percentage down. Credit tightened after the mortgage meltdown in the mid-2000s, but as of 2010, it is still sometimes possible to get loans with little money down. However, the size of the down payment will affect the overall terms of the loan.
The Mortgage Rate
Along with having a high credit score, a sizable down payment is one of the factors that should help you qualify you for a lower interest rate. A larger down payment presents less risk to the lender because if they are forced to foreclose on your property, they stand a better chance of recouping their costs. Loans with little money down are risky, so the bank charges more. Over the life of a loan, even a small increase in a mortgage rate can mean a significant difference in the final, total house cost, which makes it important for you to get the lowest interest rate you can find.
Private Mortgage Insurance
If you borrow more than 80 percent of the value of your home you will be forced to also pay for private mortgage insurance (PMI). The insurance protects the lender in the event of a default in cases where there is little equity in the property. PMI costs between 1/2 and 1 percent of the loan value each year. For a $300,000 mortgage you could be paying up to $3,000 a year just on PMI. Avoiding PMI is a strong reason to wait until you can put down 20 percent before buying.
When you calculate how much money you will have available for a down payment, don't forget other up-front costs, many of which cannot be included in your mortgage loan. You need earnest money in order to make an initial offer, but that money will go into escrow and become part of your down payment. Depending on the state in which you live, there are also attorney fees, bank fees and other related costs leading up to your closing, all of which are in addition to the purchase price.
Advantages of a Smaller Down Payment
Though a larger down payment will mean a smaller loan and consequently smaller monthly payments, it may also tie up your available cash. Once in your home, you may discover unexpected repairs and other expenses; it is always important to maintain a cash cushion. You might feel more comfortable paying a higher mortgage rate, or even PMI, in exchange for not feeling too strapped for cash. However, make sure you get a mortgage that does not have any prepayment penalties, so that when you accumulate more reserves, you can always put extra towards your principal sometime down the line to build up your equity.
Annabella Gualdoni has written newsletters and reports for corporations and nonprofits since 1994. She is a real estate professional and also teaches subjects including international cooking and travel, dating/relationships and personal finance. Gualdoni has a Bachelor of Arts in international development from University of California, Berkeley, a Master of Arts in international relations from Boston University, and a Juris Doctor from Boston College Law School.