Is a 20% Down Payment Really Necessary?

One of the questions I receive most often from my first-time home buyer clients is “can I put down less than 20%?”  The answer is an emphatic Yes! Trying to produce a traditional 20% down payment can be a significant challenge in LA, given the area’s high housing costs.  Fortunately, most lenders do not require a 20% down payment, and there are several attractive rate options for lower down payments. 

The Federal Housing Authority (FHA) offers loans with a down payment as low as 3.5%.  There are a number of loan requirements, including the buyer having a steady work history, minimum credit scores and the home meeting certain standards at appraisal. 

Veterans Affairs Loans offer $0 down payment mortgage option available to Veterans, Service Members and select military spouses. VA loans are issued by private lenders and guaranteed by the U.S. Department of Veterans Affairs (VA).

There are also several conventional loans available as well that allow for lower down payments.  For instance, CitiBank currently offers a jumbo loan (over $435,101) with a 15% down payment and no private mortgage insurance.

There are pros to both options.  By putting 20% down, you’ll avoid paying private mortgage insurance, which most banks charge.  Your monthly payment will be lower; you’ll likely earn a lower interest rate; and more banks will compete for your business.  On the other hand, putting less down -  especially in a housing market like Los Angeles where values continue to increase -  could offer you a higher rate of return on your home.  Say your home is worth $400,000. Assuming the national average appreciation rate of 5%, your home will be worth $420,000 in a year. With a 20% down payment on the home ($80,000), your rate of return is 25%. With a 3% down payment ($12,000), your rate of return is 167%.  Adjusting for rate and mortgage insurance, your rate of return is still over 100%. 

Getting approved should be your first step in the home buying process. Talking to a lender is a great way to learn about your options and find out what loan you’ll qualify for.  Having this conversation up front will help. You’ll know exactly what your budget is, and you’ll be more likely to have your offer accepted with that letter of pre-approval.