Traditionally, people put 20% of the purchase price as a down payment when buying a home. You would pay this 20% upfront as a "cash" down payment through a cashiers check or by wiring money to the seller, and get a mortgage to pay them the remaining 80% of the price of the house.

However, as a borrower, you have many more choices including some that provide you greater financial flexibility with greater risk, or more stability at higher cost.

Loan-to-Value (LTV) Ratio

Lenders like larger down payments because it reduces their risk. Putting more of your money into a deal is a sign that you are committed: you as a borrower are less likely to cut and run because you have put up a significant amount of cash upfront to buy the house. You'd lose that investment along with the house if you ran.

Larger upfront down payments also help the lender minimize their potential losses. If you stop paying a mortgage, the lender may write off the loan, foreclose and then try to resell your house. But they can't always get full market value, so the smaller the loan amount, the better. If the loan is much less than the actual value of the house, the lender stands a better chance of profiting, or at least breaking even, if you walk away from your mortgage.

The amount of the loan as compared to the actual value of the house is called the loan-to-value (LTV) ratio. In this example, if you put 20% down, the LTV is 80%. This is the norm when getting a mortgage.

Less Than 20% Down

If you want to put less than 20% down (resulting in an LTV higher than 80%), you have a couple options. The first is to get a "piggy-back" loan, where you take out another loan to pay the down payment. This loan will usually have a higher interest rate than your primary mortgage.

Your second option is to pay for private mortgage insurance (PMI). This insurance protects the lender if you stop paying your mortgage but is relatively expensive for what you personally get: nothing.

Some lenders will even allow you to borrow the entire purchase price of a house (100% LTV). You pay a premium through higher interest rates when choosing this route and you incur a significant risk. If your house goes down in value, you could sell your house and still owe money to the lender.

When you make a down payment, your loan is less than the value of the house so you have some padding should you need to sell your house if it goes down in value. Without a down payment, your padding becomes any money you have saved up for a rainy day. 100% LTV is a powerful tool but you need to understand the risk.

A more common scenario is 10% down (90% LTV) where your "piggy-back" loan is actually a fully-utilized home equity line of credit (HELOC). As you payback the HELOC, you can use the available credit much like you would a credit card with a lower interest rate. Again, HELOCs are debt and the interest charges can be significant, but they are another tool if you're disciplined with your finances.

The Thought Process

If you go into the mortgage process expecting to put down 20%, you'll generally start with some of the better rates available from that lender. From there, you can compare how much more you'll have to pay if you put less down.

Some people either don't have 20% to put down or don't want to tie up all your money in a house (i.e. you'd like to invest your cash elsewhere). Make sure that the higher cost justifies your plans. This cost may include higher interest rates for your mortgage and "piggy-back" loan, as well as PMI. If your credit card debt is significant, consider paying that off before purchasing a house so that you can be more assured of living in whatever house you buy for a long time.

Interestingly, some lenders will give you a discount on your interest rate if you put down more than 20%. (This difference in LTV should not be confused with paying points. When you pay points, you're buying a lower interest rate for the same loan amount. When you make a larger down payment, your loan amount is less and the lender may reward you with a lower rate.) A quick analysis of the cost savings vs. your goals will help determine if this choice is worth the reduced financial flexibility.

Bottom line: down payments of 20% or more will start you off with your lender's lower mortgage rates and eliminate many unnecessary fees, but if you're disciplined financially, a smaller down payment of 10% can give you more flexibility.