Why the 20% Down Payment is a Home Buying Myth

This has gotta be the greatest whodunnit in the real estate game. At some point, someone said that to buy a home, you need a 20% down payment and enough people repeated it, that it just stuck.

In this video I do a little myth busting on this

Also I go point by point here – you can jump to any section below using these links:

• What are your options if you don’t have 20% down payment saved?
• Why buy sooner versus waiting to save the 20% down payment?
• What did I do when I didn’t have 20% for a down payment?
• What if you’ve already got 20% available as a down payment?
• What are some reasons to put 20% down?

Here are a couple examples of how the 20% down payment has become part of conventional wisdom:

What are the advantages of putting 20% down? Greater purchasing power.

CNN

Putting down 20% means you have a real stake in your home from the very beginning.

Time Magazine

…but let’s put it to the test.

What are your options if you don’t have 20% down payment saved?

Matter of fact…there are plenty! All of the most common mortgage programs don’t require a 20% down payment:

• The Conventional Loan has a couple lower down payment options: depending on your qualifications you can get a 3% down payment (if you’re a first time buyer) or a 5% down payment. Note: there will be mortgage insurance and it can get pretty ugly if your credit is in the 600 range.
• FHA Loan allows 3.5% down payment and is more lenient regarding your credit score, but there’s still mortgage insurance. Depending on what your credit score is, it can be more expensive mortgage insurance than a conventional loan. This is great for first time buyers especially if you are looking to buy a duplex where you plan to live in one of the units (see my story below)
• The VA Loan: zero down payment and you don’t have mortgage insurance PLUS rates are super low. So if you happen to be a veteran or married to one, this is a great loan. Note this can’t be for an investment property. It’s gotta be owner occupied.

Ok so now we know it’s completely possible to get a home without a 20% down payment, but I can hear my Mom’s warning “just because you can, doesn’t mean you should, Julie”

So let’s ask that question…

Why buy sooner versus waiting to save the 20% down payment?

Here’s why you want to buy a home sooner instead of saving that 20% down payment:

• The property is going to appreciate, which means that the 20% amount is going to increase with it. Chasing a moving goalpost is pretty discouraging.
• It’s not just the downpayment that goes up as you wait. That monthly payment is also going to increase as the property goes up in value.
• And if you’re renting while you wait to save up that 20% downpayment, you’re not earning any equity AND you don’t have mortgage interest and property taxes to write off.

Let’s go into a real scenario of how this plays out if you’re looking to buy a house in Los Angeles.

Typical home price in Los Angeles is $1 million which means a 20% payment is $200K.

How much are you gonna have to earn in order to save $200K? You probably have to earn $300K to $350K pretax to save that $200K. How long is that gonna take? Now here’s the scary question: how much is that million dollar house gonna cost by the time you have that saved? Say no to moving goal posts people!

What did I do when I didn’t have 20% for a down payment?

True story…about 10 years ago, I didn’t have a ton of money. So I bought a duplex with 3.5% percent down (FHA Loan baby!). I lived in one of the units and rented out the other one.

Within a few years, I had 20% in equity because not only was I paying a small amount towards principle every month BUT the property appreciated, which isn’t unusual in Los Angeles.

So I refinanced out of the FHA loan to drop the mortgage insurance which lowered my overall monthly payment significantly.

Eventually I moved out and rented both of the units and the property was cash flowing.

It was a really great first step to owning real estate and it’s just as doable for home buyers now.

What if you’ve already got 20% available as a down payment?

Ok this is a tricky one. It may depend on who your financial spirit animal is: Dave Ramsey, Suze Orman, or Rich Dad Poor Dad.

But while you decide that, here’s what almost every successful real estate investors believes: when buying property, you want to use the bank’s money, not your own.

Equity in the home is nice, but putting less towards a home’s down payment means those funds can work for you in more effective ways. Here are some better uses for capital vs being trapped in your home:

• the stock market or other passive investments like bonds, REITs, etc
• renovate the property to increase its value (and you may be able to refinance into better terms AND/OR pull “cheap” money out)
• build an accessory dwelling unit (ADU) and start generating passive income from the property.

What are some reasons to put 20% down?

Devil’s advocate time. Here’s why putting 20% down on a house actually makes sense:

• avoid mortgage insurance which can add quite a bit to your monthly payment
• you may get a lower interest rate, but it’s not always the case so that’s why you’re gonna wanna talk to a loan officer and work through the scenarios
• if the market dips, you’re not gonna be underwater on your home

So what’s our recommendation?

First off, there are decent points on each side of this decision. However what I know, both from my own story and by helping thousands of home buyers is that every year you wait to buy, you’re being penalized both by the increased down payment but also the increase in monthly payment. Wouldn’t you rather benefit from these same dynamics? If so, you should be exploring the options for buying sooner and then making the decision if it makes sense for your situation.

In short, consider the 20% down payment myth BUSTED.