The 20% down payment rule for buying a house is a common guideline that has been passed down for decades. But where did this rule come from and is it still necessary today?
The 20% down payment rule originated from the Federal Housing Administration (FHA) which was created in the 1930s in response to the Great Depression. The FHA aimed to stabilize the mortgage market and set standards for lending by only insuring loans that required a 20% down payment. Eventually, this rule became a standard in the entire mortgage industry.
Fast forward to today, the 20% down payment rule is no longer a requirement. In fact, it is possible to get a mortgage with as little as 3% down. But is it still beneficial to save up for a larger down payment?
One of the main benefits of having a 20% down payment is that it eliminates the need for private mortgage insurance (PMI). PMI is an additional cost that is required for borrowers who put down less than 20% on their home. However, the cost of PMI has decreased over the years, making it less of a burden on borrowers. Additionally, interest rates on loans with less than 20% down have also decreased, making the need for a 20% down payment less significant.
Another angle to think about is the opportunity cost of giving up extra assets to meet the 20% down payment threshold. Are there other things that can be done with that asset that could be more beneficial than sinking into a mortgage? (which by the way to get that cash back out of your home can be expensive). Mortgage interest rates are generally pretty cheap and usually lower than even what the S&P 500 index's rate of return is. Simply put, you could invest the money into something that will actually accelerate your net worth rather than throwing it into a mortgage.
Ultimately, the decision of how much to put down on a new house should be based on your personal financial goals. While having a 20% down payment has its benefits, it may not always be necessary or the best option for your financial situation. We have advisors who can help you make sense of the different options and determine what is best for you. If you're considering buying a new home, schedule a call with one of our advisors for personalized guidance.
Thomas Wilson
Founder of Fox Financial
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