3.5% vs 20% Down Payment: Buy Now or Save for Later?

Introduction to the 3.5% vs 20% down payment debate

The 3.5% vs 20% down payment debate boils down to a simple question: Is it wiser to buy a home quickly after saving a small sum or to wait until you’ve saved enough to put down 20% of the purchase price?

The answer is less simple than the question. But, if you read this article to the end, you should be in a strong position to make the choice that’s smarter for you.

In this article (Skip to...)

• Pros and cons of saving for a 20% down payment
• Pros and cons of buying now with 3.5% down
• 20% vs 3.5%: Factors to consider when choosing
• The bottom line
• FAQ

Minimum down payments

Different types of mortgages have different minimum down payments. Of course, you can always choose to pay more than the minimum, and that brings advantages, but you won’t qualify for that loan if you don’t meet the threshold.

If your savings are short, check out down payment assistance programs. These can provide financial help to bridge the gap between your savings and your down payment needs.

Our “3.5% vs 20% down payment” headline compares an FHA loan (backed by the Federal Housing Administration) with a conventional mortgage (one not backed by the government). But there are others.

For example, a conventional loan that conforms with Fannie Mae’s or Freddie Mac’s rulebook has a 3% minimum down payment. And government-backed VA loans (Department of Veterans Affairs) and USDA loans (U.S. Department of Agriculture) require zero down payment to the select groups who are eligible borrowers.

So, why would anybody think of paying more than the minimum? That’s coming up next.

Pros and cons of saving for a 20% down payment

Pros:

There are real financial benefits when you put down 20% or more on your home purchase. Federal regulator the Consumer Financial Protection Bureau sums up: “There are a variety of mortgage options that allow you to make a down payment of less than 20 percent, but lower down payment loans are typically more expensive. In general, the less money you put down upfront, the more money you will pay in interest and fees over the life of the loan.

The benefits of a 20% down payment include:

• You borrow less — Suppose you want to buy a $200,000 home. If your down payment is 20%, you need to borrow and pay interest on only $160,000. ($200,000 price x 20% down payment = $40,000 down payment. $200,000 price - $40,000 down payment = $160,000 loan). But, a 3.5% down payment would mean you borrow $193,000. ($200,000 price x 3.5% down payment = $7,000 down payment. $200,000 price - $7,000 down payment = $193,000 loan)
• You don’t pay mortgage insurance — If your down payment is less than 20%, you must almost always pay mortgage insurance premiums, which can run into hundreds of dollars a month. VA loans are the sole mainstream exception
• You typically get a better deal — Borrowers with higher down payments are statistically less risky for lenders. They have more skin in the game. So, lenders will often reward them with lower mortgage rates and perhaps reduced closing costs

Those are powerful motivators to save 20%. But don’t decide on anything until you’ve considered the downsides.

Cons:

When Rocket Mortgage analyzed Census data in late 2023, it found that 44% of first-time buyers made down payments of less than 10% of their homes’ purchase prices. And there are good reasons why relatively few such buyers wait to save 20%.

• You miss out on rising home prices — This is crucial in the 3.5% vs 20% down payment debate. All the time you’re saving for your big down payment, you’re not a homeowner. And, if home prices are rising quickly, you face a double whammy: You’re not benefiting from price appreciation, and your savings target is constantly moving higher
• You’re wasting money — Assuming you’re renting, you’re paying down your landlord’s mortgage instead of your own
• You’re probably cash-poor —Money that’s tied up in an unnecessarily high mortgage down payment can’t be used for other purposes. You may not have an emergency fund to cover major defects in your home or other financial issues in your life
• Your finances are less flexible — You can’t use that tied-up money to make more money. So, you can’t cash in on a stock market boom or a bitcoin surge or whatever investment opportunity floats your boat. Economists call this an opportunity cost

The 3.5% vs 20% down payment dilemma

The upsides and downsides of a 20% down payment seem fairly evenly matched. Do the pros outweigh the cons for you? Or is it the other way around?

Keep reading to uncover other elements in the great 3.5% vs 20% down payment debate.

Pros and cons of buying now with a 3.5% down payment

When considering purchasing a house with a down payment as low as 3.5%, there are various factors to weigh. Below, we’ll delve into the advantages and disadvantages of this approach to help you make an informed decision.

Pros

• You reap the rewards of homeownership sooner — If home prices are rising quickly, you’re building equity in your home fast. Meanwhile, someone saving for 20% has no equity and faces an uphill struggle to save more and more to match rising prices
• You’re pouring less money down the drain —Because your monthly payments benefit you, not your landlord
• You’re free to retain more cash in your emergency fund. So, sudden expenses are way less scary
• You might be more cash-rich — Why not spend some on home improvements or things you care about?
• You can make your money work — If you’re not saving every penny for a down payment, you may have spare cash for investing and building your net worth

Cons

• A small down payment could cost you more — You’re borrowing more and will have to pay interest on the extra. And that could easily add up to five figures or more over the lifetime of your loan. Plus, you might face a higher mortgage rate. Do you think rising home prices will compensate for these? They may or may not, depending on your local residential property market
• You’ll likely face costly mortgage insurance — This can come in at hundreds a month. You can make a good case for paying it. But you need to decide that it’s worth it

3.5% vs 20% down payment: Factors to consider when choosing

There’s no single right or wrong answer in the 3.5% vs 20% down payment debate. Some will be better off choosing the first and others the second.

Home price trends

Perhaps the single biggest factor that should affect your decision is your local housing market. Are home prices rising where you’re buying? How quickly are they increasing? And do you think they’ll continue to move on the recent trend?

Generally, you can research forecasts for home price trends. They’re probably your best guide. But bear in mind that experts can get these things wrong.

As importantly, there are usually areas of the country in which home prices are falling, even when they’re rising sharply nationwide. In these, adverse local economic conditions often mean fewer people want to move there, reducing demand and lowering sales prices. So, pick the brains of local real estate agents and landlords to get a feel for the prospects for your local market.

If home prices are falling or stagnant where you want to buy, you can take all the time you need to save a 20% down payment. You’ll get the financial benefits of a big down payment without missing out on the equity that rising prices bring.

Your personal financial situation

Here are things to look at:

• Income — If you (and maybe your partner) have high incomes, you might be able to save a 20% down payment in a year or so. If home prices are rising moderately, it may be worth taking that time
• Savings — Suppose you’re already close to your savings target. You might well benefit by sprinting the last mile to get to 20%
• Debts — Lenders will penalize you with a higher mortgage rate if you’re burdened with existing debts that are too high. They might even decline your application. So, it may be worth diverting some of your savings into paying down the most onerous debts. But read How to Get a Loan With a High Debt-to-Income Ratio

Long-term financial goals

It’s advisable to look at your homeownership plans within the wider context of your long-term financial goals. How do they fit into your retirement plans, investment objectives, and life goals, such as having kids or caring for elderly parents?

Take a step back and consider all these holistically. Are some goals in conflict with others? If so, what are your personal priorities? Now may be a good time to consult a financial advisor.

The bottom line: 3.5% vs 20% down payment

So, do you know where you stand in the 3.5% vs 20% down payment debate? We know that there’s no right answer. One suits some and the other others.

What will swing it for you will depend on several things, including:

• What’s happening (and will likely happen) to home prices where you plan to buy
• How much you’ve already saved
• Your ability to save quickly
• How much you’re paying in rent and how that affects your saving capacity
• And how your homeownership plans fit into your long-term financial goals

But even when you assess these carefully, you can’t be sure you’re making the right choice. Because each of those might change as the years roll on. So, all you can do is plan as diligently as you can and make a decision based on the best information you have.

FAQ