Know your down payment options: Why 20% is no longer king

If you’re shopping for a new home, someone might’ve mentioned the golden rule of homebuying: You must make a 20% down payment to secure a mortgage.

For decades, the gold standard was a 20% down payment. Today, you may mistakenly believe that, until you have socked that much away, your hopes for home ownership are dim. And while making a down payment that large is a good target to aim for,  20% down isn't the only option for home ownership.

If it’s not a requirement, what are your down payment options? Let’s take a look.

Homebuyers can now choose from a range of financing options that allow them to put down as little as 3% of the home’s purchase price. And some options enable you to secure a mortgage with no down payment at all. In fact, according to the Federal Home Loan Mortgage Corporation (also known as Freddie Mac), 40% of today’s buyers make down payments of less than 10%.

Not every lender will offer all of these types of loans, so check which options are available through your lender. Ally Home Loans offers the HomeReady Program as an option for borrowers who meet the requirements.

Finally, if you have a good credit score and/or don’t qualify for one of the above loan options (for one reason or another), you can still make a low down payment and be approved for a mortgage. But you’ll likely need to get private mortgage insurance (PMI).

PMI functions as an insurance policy for your lender, protecting them in case you’re unable to make your mortgage payment.

Borrowers pay a monthly PMI fee as part of their monthly mortgage payment. PMI costs vary depending on your credit score and your loan-to-value ratio, which is the value of your house compared to the mortgage balance.

While PMI will increase your monthly costs in the short term, you aren’t required to maintain coverage the entire lifespan of your loan. Once you have paid down your mortgage loan and have 22% equity in your home’s purchased value, it will be cancelled automatically. Consider making additional principle payments to get there sooner, or you can even request cancellation when you have 20% equity, though it's not guaranteed.

Of course, the more you can “put down” on your home, the better. Down payments of at least 20% can mean lower monthly mortgage payments, a better hedge against declines in real estate values, and often, better interest rates, fewer upfront fees, and lower closing costs. Luckily, if you find saving for a large down payment is difficult, there’s a range of affordable down payment loan and even no down payment loan options to keep you from being locked out of a new home.