The 20 percent rule is not as accurate as you think it is.

Home buying is such a complicated process that bookcases of books have been written on the subject. Courses for first-time home buying and real estate investment are the foundation of some people’s businesses. Laws upon laws have been passed to make the process more beneficial for buyers, and yet the process is still one of the least understood.

Which is too bad, because homebuying is an essential piece to the wealth-building puzzle—no matter who you are. Homeownership is a cornerstone of financial security, and a way families can protect themselves, both serving as a shelter and a nest egg to pass on to the next generation.

This article will uncover the critical facts and figures you need to know when deciding how much money you need for your home purchase

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What is a Down Payment?

A down payment is the portion of a house’s purchase price that the home buyer pays upfront. Once the home is purchased, the down payment becomes the equity owned by the new homeowner. Down payments are typically expressed in the percentage of the purchase price. Different financing options have different requirements for down payments

“How Much House” Can I Afford?

This is a more complicated question than it seems. Many first-time homebuyers think that a mortgage equal to what they’ve previously paid in rent is fine, but this is not always the case. Even though homeowners benefit from gaining equity in the home, homeownership is often more expensive month-to-month than renting. 

While the monthly payment for your mortgage may be lower than rent, you have to cover other costs as well:

  • Home insurance
  • Taxes
  • Repairs and maintenance
  • Utilities
  • HOA fees if applicable
  • Mortgage insurance, if applicable

But there are still other constraints besides your personal budget. You also need to be sure that your new home purchase price, minus the down payment, does not exceed limits for your debt-to-income ratio (DTI). 

Lenders like to see a DTI below 40 percent, and the “debt” in your DTI refers to all your debt: 

  • Student loans
  • Car loans
  • Personal loans
  • Credit cards

So when it comes to deciding how much house you can afford, you need to find a number that works for you. A house price that works for you is one that fits your budget while allowing you to save toward other financial goals. 

Our recommendation is to be moderate with your debt agreements. While leveraging debt is often key to financial success, it can also cause financial problems. Moderation, caution, and restraint are your best tools when it comes to choosing the right home price.

How Much Money Do I Need?

The truth is, it depends. How much money you need to buy your home depends on your ability to save money, your financial goals, and the type of financing you use. In the past, 20 percent of the purchase price has been the battle cry of home buying. Many people believe that without 20 percent down, home buying is impossible. Frankly put: 20 percent is an ideal amount, but it is not the cutoff. 

You have many down payment options. Most people can buy a home with a minimum down payment of three and a half percent. For some home loans, like ones designed for veterans, no down payment is required. Not to mention a plethora of federal, local, and non-profit initiatives can even grant you money to use to buy a house. 

Still, that doesn’t mean you’re guaranteed approval with a low down payment. Your credit score and credit history will have a significant effect on whether or not your lender will approve a smaller down payment. If your score is less than stellar, do what you can to raise your credit score. The lower your score, the more you’ll need to pay upfront to show you’re ready for homeownership

Additionally, the more money you put down, the better your chances of getting a lower interest rate. That’s because mortgage lenders like to see a low loan-to-value (LTV) ratio. That means that the loan amount is lower than the value of your home. Lenders want to see this because your home acts as collateral for the loan. If the collateral is a significant portion of the loan amount, it makes the investment less risky for the lender.

Even half a percent can save you thousands throughout the mortgage loan. Additionally, putting down 20 percent means you don’t need to pay for private mortgage insurance (PMI).

PMI policies protect your lender if you default on your mortgage. Lenders typically require mortgage insurance for mortgages where the homebuyer owns less than 20 percent of the equity in the home. 

It’s Not All About The Down Payment 

Your down payment amount is only one cost associated with home buying. The process itself is quite expensive and full of fees first-time buyers won’t be familiar with. In addition to the down payment, you also need to cover:

  • Home inspection
  • Closing costs
  • Realtor fee
  • Immediate repairs if applicable
  • Moving costs

It’s always a good idea to get a clear understanding of how much you’ll be expected to pay out of pocket beyond your down payment. Your realtor can help you estimate your costs. 

Down Payment Requirements by Type of Financing

Home Loan Down Payment  PMI Suited For
Conventional Loan 3% Y Buyers with a Fair or better credit score
Freddie Mac or Fannie Mae Loan Programs 1% Buyers without 
Federal Housing Administration FHA Loans 3.5% Y Buyers who want to take advantage of FHA loan benefits

Buyers with a Poor credit score

Department of Veterans Affairs VA Loans 0% N Veterans and current members of the U.S. military
U.S. Department of Agriculture USDA Loan 0% Y People living in or interested in moving to rural areas

How Can I Save More Money For My Down Payment?

You may be able to find down payment assistance through a government program or a non-profit. Often these come in the form of low-interest down payment loans. There are also many grants available to people willing to move to areas that need revitalization. Don’t be shy when it comes to research. 

Beyond grants and assistance, saving for a down payment is all about how well you can save money. But saving money isn’t just about homeownership. Saving money is about financial freedom, and homeownership is a milestone in the journey. 

When it comes to saving more money, you have two options:

  • Make more money and save it.
  • Spend less money and save more of your current income.

You can make more money by adding a side gig or selling your gently used stuff online. Spend less by reviewing your budget and cutting expenses where it makes sense. The less you spend now, the more buying power you will have in the future. 

Pro Tip: Automate your savings to make things even easier. 

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Should I save 20 percent?

Putting 20 percent of your purchase price into your home is almost always a great thing. You’ll pay less in the short term and in the long run. That being said, 20 percent can be too expensive for some budgets. Additionally, a homebuyer can still end up saving money when switching to homeownership even with the added cost of mortgage insurance. This is especially true over time: as rent prices increase, your mortgage does not.  The choice is up to you and your buying partner if you have one. Whatever you choose, be sure it fits with your personal finance goals. 

Where should I keep my down payment savings?

Your down payment savings belongs in a high-interest savings account. You can also put the money in a high-interest certificate of deposit so long as you can access the money freely when it comes time to buy. If you’re saving as a couple, you can also use the Twine app to easily save together.  The bottom line is: your nest egg should be kept in an easy-to-access savings vehicle. 

Conclusion: Save More If You Can

As we’ve said, putting 20 percent down when purchasing a home is ideal. It saves you on the 

  • Monthly mortgage payment
  • Mortgage rate
  • Mortgage insurance premium

Even so, it may not be possible for every homebuyer. For others, taking on mortgage insurance may still be cheaper than paying out rent increases. The key to getting the down payment right is to know your options and choose wisely. We believe in you! 

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Updated June 19, 2020

J.J. Starr is a financial copywriter and enjoys helping readers find the information they need. In addition to her background in banking and financial advising, she is also a poet with an MFA from New York University. She lives in Amherst, Massachusetts. You can learn more at jjstarrwrites.com.