What is a down payment on a home?
The down payment is a portion of the total sales price of your home, which you give to the home’s seller. The rest of the payment to the seller comes from your mortgage. Down payments are expressed as percentages. A down payment of at least 20 percent lets you avoid private mortgage insurance, or PMI.
To explain how bankers and real estate agents talk about down payments, let’s say you buy a house for $100,000:
- A 3 percent down payment means that you pay the seller $3,000 and you borrow $97,000.
- With a 20 percent down payment, you would pay the seller $20,000 and you would borrow $80,000.
Sometimes you’ll hear a phrase like, “Alex put 20 percent down on the house.” That means that Alex made a 20 percent down payment.
The money for a down payment can come from:
- Your own savings.
- The money you get when you sell a house.
- Gifts and grants from family, employers and nonprofits.
Why mortgage lenders require a down payment
For lenders, whether it’s a bank, credit union, or non-bank lender, a down payment helps offset their risk. The more money you have invested in a house, the less they end up losing if they foreclose. This is why borrowers who put less than 20 percent down usually have to get PMI. PMI protects lenders by repaying that portion of the loan if it goes into default. PMI will increase your monthly mortgage payments.
Likewise, by financially investing in the house upfront via a down payment, you’re showing that you’re invested in the property. The down payment can affect your interest rate, as lenders will typically offer a lower rate to borrowers with larger down payments.
Finally, a down payment play as role in determining the amount you can borrow. Along with credit score and debt, banks look at the loan-to-value (LTV) ratio as part of the mortgage approval process. The larger your down payment, the better your LTV will be.
Saving for a down payment before you shop offers big benefits
Many financial experts agree that having a down payment is a good sign that you’re ready for homeownership. If you can make the necessary sacrifices to save up for a down payment, then you’ll likely be able to manage expenses that come with owning a house, including monthly mortgage payments, costly repairs and property tax.
Down payments also protect buyers from negative equity if the market suffers a downturn. Let’s say you put 3 percent down and the market value falls by 5 percent, you’ll be upside down on your mortgage by 2 percent. Essentially, you’ll owe more than what the house is worth. However, if you put down 20 percent then you’ll still be ahead of the game. For homeowners, offsetting negative equity risks with a substantial down payment is helpful if they need to sell the house.
What is the minimum down payment on a house?
The amount you’ll be required to put down on a house depends on the type of loan you get and lender requirements. Normally, a 20 percent down payment is what’s expected for conventional loans, that up to the $485,850 limit for conforming loans.
Other factors like credit score and debt-to-income ratio can influence how much of a down payment lenders require to approve your loan.
FHA loans only require a 3.5 percent down payment for borrowers with a credit score of 580 or higher. Those with a lower credit score will need a 10 percent down payment to qualify for an FHA loan. These borrowers are required to pay two types of mortgage insurance:
- Upfront mortgage insurance premium (MIP) and
- Annual MIP
The upfront MIP is 1.75 percent of the base loan total and the annual MIP varies by the length of the loan and how much you put down. For 30-year fixed-rate loans with an LTV less than 95 percent, you’ll pay .80 percent or 80 basis points; the same loans with an LTV higher than 95 percent, have an MIP of .85 percent or 85 basis points.
How to calculate your MIP
To figure out how much your monthly insurance premium, or MIP, will cost you, simply multiply the loan amount by the MIP amount and divide the total by 12. Let’s say your mortgage is $200,000 and your MIP is .80 percent, you would multiply 200,000 x .008, which comes to 1,600. Next, we divide 1,600 by 12, which equals 133.33, rounded to the nearest cent. Your total monthly MIP would be $133.33.
USDA loans also require MIP for borrowers who don’t have a 20-percent down payment. The upfront MIP costs 1 percent of the total loan amount and the annual MIP is .35 percent of the loan amount.
VA home loans, which are provided by private lenders, do not require down payment or PMI, which is an advantage for qualified veterans. The reason that VA borrowers escape the PMI requirement is that since the VA guarantees a portion of the loan, the lender’s risk is already mitigated. In this instance, a down payment isn’t necessary.
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Bigger down payment = more house
Finley and Kerry each can afford to spend about $925 a month on a house payment, excluding taxes and homeowners insurance. Kerry has $15,000 more saved for a down payment and can afford to spend about $32,000 more for a house.
Smaller vs. larger down payment
|Homebuyer||House price||Down payment amount||Percent down||Monthly principal and interest||Monthly PMI||Total monthly payment|
|Homebuyer: Finley||House price: $167,667||Down payment amount: $5,000||Percent down: 3||Monthly principal and interest: $776.60||Monthly PMI: $149.11||Total monthly payment: $925.71|
|Homebuyer: Kerry||House price: $200,000||Down payment amount: $20,000||Percent down: 10||Monthly principal and interest: $859.35||Monthly PMI: $66||Total monthly payment: $925.35|
Assuming a 4% interest rate.
Source: Bankrate.com, Radian mortgage insurance calculator