By Jesse Herman, contributing editor
In light of rising foreclosure rates and lending scandals, many people are calling for conservative approaches by mortgage lenders and borrowers. The tendency is to look at a 20% down payment as the best way for borrowers to receive great mortgage rates and lenders to have the safest investment. In many respects this still holds true. The idea that you should wait until 20% of your mortgage loan is saved, though, is a myth.
Set Back the Time Machine
We have entered the 1950’s. Dean Martin and Elvis Presley rule the airways. Acclaimed writer/director Billy Wilder opened the decade setting trends in the movie industry, releasing Sunset Blvd (1950) and closing it out the same way with Some Like it Hot (1959), starring controversial actress Marilyn Monroe. 1956 was the year in which the first Trans-Atlantic phone cable was laid.
It was a different era. 
When banks would foreclose on a house they would want to sell it quickly. If the bank is not generating income from interest then they would want to sell to someone who will pay interest. In order to do this they would lower the price of a home, just like today.
The standard amount to lower a homes price and in order for it to sell quickly was: 20%.
Just like that, the 20% standard was established. The 20% gave banks security in knowing that if the home foreclosed, they could drop the price 20% and sell it with ease while getting their money back.
Banks were involved in a win-win situation. Borrowers swallowed all the risks.
The Slow Ride to Now
Now we slowly crawl up the American timeline to find the 20% standard sprouting with many variations. Through the Private Mortgage Insurance (PMI) Industry, a bank agrees to allow a down payment less than 20% as long as the homeowner takes out an insurance policy. This policy is paid monthly to a third-party or the bank. If payments are not made, then the bank can cash the PMI policy.
These policies generated great revenue for banks and kept them out-of-risk. Still, there was more revenue to be made. There were other methods that could be utilized that would not require money to be paid to a private insurance company. This idea spawned what we know now as Home Equity Loans and Home Equity Lines of Credit.
The banking industry developed a plan where they would lend on the first 80% of a home and then create a separate, higher rate mortgage loan and for the difference between the down payment and home value.
Through a second mortgage, or home equity line of credit, a person could even make a down payment without dipping into their own funds.
Second mortgages are great for banks, as they have considerably higher interest rates (depending on credit score, amount borrowed, total mortgaged vs. home value).
The 20% rule does not apply today, but is still a measuring point used by banks to determine what rates will need to be paid. Common sense tells us that the more you borrow the more that will need to be paid back. This is true and it is also important to remember that a bank is going to protect itself no matter how much they lend. This protection was once through a 20% down payment, then through PMI and now with higher monthly payments.
There is substance to the 20% rule, but only from a historical perspective in gauging what works today.
