Do I Really Need a Down Payment When I Purchase a Home?

Houses on stacks of coins
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Traditionally, you needed to have a down payment of between 10% and 20% of your home costs saved up before you purchased a home. Mortgage lenders did this to protect themselves because it indicated that you would be more responsible with their money. It also protected them, because they did not loan out the full value of your home. If you were to default on the loan, they were more likely to make a full recovery from the loss.

In recent years, however, things have changed. It is now possible to purchase your home with no down payment at all. This may sound like good news, but there is reason to be cautious.

Avoiding the Down Payment

Some banks now offer 100% financing for a home. Certain couples may also qualify for an FHA loan, which eliminates the need for a large down payment. Banks also offer mortgages with easier qualifications, but this might not be the best option due to higher interest rates and closing costs.

When you don't have 20% to put down, you usually have to pay private mortgage insurance (PMI) in some form. But some people have even taken out two loans in order to avoid the cost of PMI—and still not have a down payment on their home.

The best way to avoid these costs, however, is to save up for a down payment for your home, if possible. This is a better approach for several reasons.

Reasons to Have a Down Payment

First and foremost, a down payment proves that you are financially ready and responsible enough to buy a home. When you purchase a home, you are responsible for all of the maintenance costs related to it. You will need to pay for repairs and homeowners insurance. Saving up for a down payment proves to yourself and the bank that you are in a position to make those sacrifices. In many cases, your mortgage will be higher than the rent you're paying, so your ability to save demonstrates that you are ready for the increase.

Another reason to have a down payment is that it protects you in case you need to move and the housing market has dropped. Many people can't sell their homes because they bought them without a down payment when housing prices were at their peak, and now they owe more than their home is worth. There is no pretty way out of this situation. Either you will lose lots of money or you will ruin your credit—or you will do both.

Many people in this situation hang onto their homes, hoping that the situation will improve. Using a down payment does not completely prevent this from happening to you, but it does give you a solid buffer against a downturn. Unless your home value falls more than 20%, you are much better off since you started with some equity.

Avoid Buyer's Remorse

Making a down payment on a home helps avoid any regret of buying your home. In addition to showing that you are financially prepared to purchase a home, saving up for a down payment will allow you to purchase a home that you will like and you will not regret buying.

The down payment can increase the size of home you can afford, and it can help you buy one in a better location. Essentially, it gives you more choices because you will still qualify for the same amount on your mortgage; the down payment is just extra money that can increase your purchasing power.

When and How to Buy

When mortgage rates are low, you may be feeling the pressure to purchase right away, even if you don't have a down payment, so that you can save money in interest over the life of your loan. It is true that you may save money, but you cannot see the future. You don't know if housing prices are going to rise or if they will fall again. Nor do you know if you will need to move suddenly due to a new job or a transfer, leaving you unable to sell because of how much you owe on the home. Your down payment is some extra padding between you and the unknown.

When you do decide you are ready to purchase a home, you need to make sure that you choose the best mortgage with a fixed interest rate. An adjustable-rate mortgage will cause your mortgage payments to go up as the interest rate increases. Finally, be sure you have some extra money saved for home repairs. This will ensure you're ready for the unpredictable costs of home ownership.