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Buying Your First Home

Down Payment Options: 3% vs 20%

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Down Payment Options: 3% vs 20%

A larger down payment reduces monthly costs and eliminates PMI, but locks capital away from investments. The right choice depends on your interest rate, time horizon, and conviction about future returns.

Key takeaways​

  • Down payments range from 3% (FHA, some conventional) to 20%+ (jumbo loans, cash buyers).
  • PMI (private mortgage insurance) applies to loans with LTV (loan-to-value) above 80%, typically costing 0.5–2% annually.
  • A 3% down payment lets you deploy capital to other assets; a 20% down payment eliminates PMI but ties up liquidity.
  • On a $350,000 home, the difference between 3% and 20% down is $59,500—invested at 7% for 30 years, that's $660,000 in opportunity cost.
  • The "right" choice depends on whether your mortgage rate (5–7%) is lower than expected stock-market returns (7–10% historical).

The menu of down payments​

3% down: Minimum for most conventional loans. You borrow $339,500 on a $350,000 purchase. Loan-to-value (LTV) is 97%. PMI is mandatory, typically 1.0–1.5% annually (around $340–$510/month).

5% down: Common for first-time buyers. LTV is 95%. PMI is similar, around $255–$425/month.

10% down: Better than 5%, same PMI structure (0.5–1.2% annually). LTV is 90%.

15% down: LTV is 85%. PMI might drop slightly, and some lenders offer better rates.

20% down: The "magic number." LTV is exactly 80%, no PMI required. No lender insurance cost.

Example on a $350,000 home at 6% over 30 years:

Down %Down $Loan $P&IPMI/moTotal P&I+PMI
3%$10,500$339,500$2,037$425$2,462
5%$17,500$332,500$1,995$332$2,327
10%$35,000$315,000$1,892$237$2,129
15%$52,500$297,500$1,785$158$1,943
20%$70,000$280,000$1,679$0$1,679

Monthly difference between 3% and 20%: $2,462 − $1,679 = $783. Over 30 years, that's $282,000 in higher payments—but much of that is PMI, which stops eventually.

PMI: How long does it last?​

PMI is not permanent. As your home appreciates and you pay down principal, your LTV drops. Once you've paid the mortgage down to 80% of the home's current value (or original value, depending on the lender), you can request PMI removal.

Example: You buy for $350,000 with 10% down ($315,000 loan). If the home appreciates to $385,000 in 5 years and you've paid principal down to $300,000, your LTV is now 77.9%. You can request PMI cancellation—instant monthly savings of $237.

However, PMI termination isn't automatic; you must request it and often pay for a new appraisal. Some loans automatically drop PMI at 78% LTV; others require you to reach 80% principal and request removal.

FHA loans are worse: PMI (called MIP—Mortgage Insurance Premium) is permanent if your down payment is less than 10%. A 3% FHA down payment means PMI for the life of the loan (or refinance). This is a major hidden cost of FHA loans.

The opportunity-cost argument​

Here's the case for 3% down: If your mortgage rate is 6% and you expect stock-market returns of 8–10% (based on historical averages), deploying that $59,500 (the difference between 3% and 20% down) into index funds should outpace the 6% mortgage cost.

$59,500 invested at 8% compounded annually for 30 years grows to $784,000. Your extra mortgage payments and PMI over 30 years total roughly $285,000. Net gain: $499,000 by going 3% down instead of 20% down.

But this logic has three catches:

  1. You must actually invest the $59,500. Many people don't. They spend it or leave it in a savings account earning 0.5%. Then 3% down just costs them the PMI premium with no offset.

  2. Stock returns aren't guaranteed. The market returned 10% annually from 1950–2020, but there are 20-year windows (1966–1986) where returns were mediocre. If you're unlucky with market timing, a 6% certain mortgage might beat an 8% uncertain stock return.

  3. Behavioral risk. With 20% down, you own more equity—psychologically, it feels like yours. With 3% down and leverage, a market downturn can tempt you to default (underwater mortgage). This isn't rational, but it happens.

When 3–10% down makes sense​

  • You have strong income, stable job, and 6+ months emergency reserves.
  • Mortgage rates are 5–6%; stock markets are historically cheap (P/E under 15).
  • You're disciplined enough to invest the down-payment difference.
  • You have a high income bracket where mortgage interest is tax-deductible (though this benefit is limited under current tax rules).

When 15–20% down makes sense​

  • You've been saving for years and want peace of mind.
  • You're risk-averse and dislike leverage.
  • Interest rates are high (7%+), and mortgage-rate spread over stock returns is narrow.
  • You expect to stay in the home 30+ years and want to be mortgage-free by retirement.
  • You're buying in a volatile market (tech hubs, coastal areas) where downside risk is real.

FHA vs. Conventional: PMI differences​

FHA loans allow 3.5% down but have two insurance premiums:

  1. Upfront Mortgage Insurance Premium (UFMIP): 1.75% of the loan amount, added to your loan balance.
  2. Annual Mortgage Insurance Premium (AMIP): 0.5–0.80% annually, depending on LTV and loan term.

On a $336,500 loan (96.5% of a $350,000 purchase):

  • UFMIP added to loan: 1.75% = $5,888
  • New loan balance: $342,388
  • AMIP annual: 0.85% = $2,911/year ($243/month)

Over 30 years, FHA mortgage insurance is front-loaded and permanent (if down payment under 10%). It's only cheaper than conventional if you plan to refinance within 5 years.

Conventional loans at 5% down have similar annual PMI ($170–$330/month on the same $350,000 purchase) but become removable once you hit 80% LTV through appreciation or principal paydown.

Worked example: 3% vs. 20% over 30 years​

Home price: $350,000. Mortgage rate: 6%. Time horizon: 30 years.

3% Down ($10,500 down, $339,500 loan):

  • Monthly P&I: $2,037
  • Monthly PMI: $425 (first ~10 years, then drops)
  • Average total monthly: $2,231 (accounting for PMI removal after 10 years)
  • 30-year cost: $2,231 × 360 = $803,160

20% Down ($70,000 down, $280,000 loan):

  • Monthly P&I: $1,679
  • PMI: $0
  • 30-year payment cost: $1,679 × 360 = $604,440
  • Add upfront capital: $70,000 − $10,500 = $59,500 opportunity cost (or opportunity gain if invested)

If the $59,500 (3% vs 20% down difference) is invested at 8% annually: future value = $784,000.

Net benefit of 3% down: $784,000 (investment gains) − $198,720 (extra payments) = $585,280 ahead.

But if the $59,500 goes uninvested, you're $198,720 behind—worse off entirely.

Decision tree​

Next​

You've decided your down payment. Now you need to understand the types of mortgages available—conventional, FHA, VA—each with different eligibility rules, costs, and occupancy requirements that shape your decision.