The Benefits of a 20 Percent Down Payment for a House

All lenders used to automatically require a 20 percent down payment when you purchased a home. But as home costs rose, many borrowers found it difficult to save up that much, as a result homeownership fell and the pressure was on lenders to accept smaller down payment amounts. There are benefits to saving up for a 20 percent down payment anyway – even though it can be a hefty sum, paying that much up front pays off for you in the long run.

More Equity

As a homeowner, you may wish to borrow money against your home’s equity; the equity is the total value of your home minus the outstanding balance of your mortgage. For example, if your home value is $150,000, and you currently owe $100,000 on your mortgage, your home’s equity is $50,000.

Many lenders will let you use this equity as collateral for other loans – but not until you have repaid at least 20% of the value of your home. So if you put 20% down on your home up front, you will have equity in your home from the first day you move in.

This should be used with caution because in tough economic markets, many lenders tighten their guidelines and do not offer loans, no matter what the circumstances. For example, because of the recent real estate downturn, lenders have now restricted cash loan to values to 65 to 75 percent of the value of property and made an excellent credit score a mandatory credit requirement.

Better Interest Rates

Lenders usually give better interest rates to borrowers whom they believe are a safe risk. If you are able to make a 20 percent down payment on your home, your lender believes you are less likely to walk away from your mortgage and go into foreclosure. If you have the money for a large down payment, you will most likely be able to continue to have enough income to pay off your loan and negotiate a lower interest rate.

A Smaller Loan – And Smaller Interest

The more money you start with, the less you will need to borrow. And, the less money you need to borrow, the smaller your monthly payments. You will pay less interest with smaller loans.

Suppose your home is worth $100,000, and you get a 30-year mortgage with a 6% interest rate.  If you make a 20% down payment of $20,000, you would only need to borrow $80,000, and you would pay an additional $92,670 in interest.  If you borrowed the full $100,000 at the very same rate, though, you would pay an extra $115,838 in interest – a difference of over $23,000. 

Lower Closing Costs

If you cannot make a 20% down payment, your lender may also require you to purchase PMI, or private mortgage insurance. But this insurance is not for you – it is for your lender, to protect them in the event you have to default on your mortgage before your home has enough equity. Usually, once your lender has been repaid 20% of your home’s equity, they will cancel this PMI. But if you pay 20% down from the start, your lender will not need this PMI in the first place – so you never have to pay it.