What is a down payment on a home?
A down payment is the portion of the sale price of a home that is not financed. This is the buyer’s cash equity in the home with the remainder paid over time in the form of mortgage payments.
Down payments are expressed as a percentage of the total sale price. A down payment of at least 20 percent lets you avoid private mortgage insurance, or PMI, which can add significantly to your monthly payment.
How to calculate a down payment
If you’re buying a house for $100,000:
- A 3 percent down payment means that you pay $3,000 initially.
- With a 20 percent down payment, you would pay $20,000 initially.
The money for a down payment can come from:
- Your savings.
- The money you get when you sell your current house.
- Gifts and grants from family, employers or nonprofit organizations.
Why mortgage lenders require a down payment
For lenders, whether it’s a bank, credit union, or other type of lender, a down payment helps offset their risk in making a mortgage loan because it means the borrower immediately has some skin in the game–an investment to protect. The more money you pay down, the less the lender stands to lose if you default on payments and the lender has to foreclose, especially early in the loan term. This is why borrowers who put less than 20 percent down usually have to get PMI, as it protects lenders by repaying the unpaid portion of the loan if the borrower defaults.
The amount of the down payment can affect the interest rate you get, as lenders will typically offer lower rates for borrowers who make larger down payments.
Finally, down payments play a role in determining the amount you can borrow. Along with credit scores and debt levels, lenders look at the loan-to-value (LTV) ratio (the amount loaned relative to the value of the home) 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 can yield significant benefits
Many financial experts agree that having saved up a down payment is a good sign that buyers are ready for homeownership. If you can make the necessary sacrifices to amass a down payment, lenders take this as a sign that you’ll likely be able to manage your finances to pay the expenses that come with owning a home, including monthly mortgage payments, repairs and property tax.
Down payments also protect buyers from negative equity if the market suffers a downturn. If you put 3 percent down and the market value of the home soon falls by 5 percent, you’ll be upside down on your mortgage by 2 percent; you’ll owe more than what the house is worth. However, if you had put down 20 percent, then you’ll still have equity in the home. A substantial down payment to reduce negative equity risk is not only attractive to lenders, but is also helpful in the event that owners need to sell the home for some reason.
What is the minimum down payment on a house?
The amount you’ll be required to put down on a home depends on the type of loan you get and on the lender’s requirements. Generally, it can be difficult to qualify for a conventional mortgage loan–one available through or guaranteed by a private lender or either of two government-sponsored entities, Fannie Mae or Freddie Mac–with a down payment of less than 10 percent. Factors including income, cash on hand, credit score and debt-to-income ratio.
How much is the average down payment?
In a study last year, the National Association of Realtors found the average down payment was 12 percent. A 2017 report by Attom Data pegged the average at 7.6 percent. For first-time buyers, the average is lower still with various reports stating it’s 7 percent or less.
How much should you put down on a house?
How much you should put down on a house is a personal decision that mainly depends on your finances and what loan program you use.
If you’ve saved up a good chunk of money over time or have a windfall you can apply to a down payment, you’re ahead of the game. But if you’re just starting out, it could take months or even years to save for a down payment. There are closing costs to consider, too.
Some loan programs allow you to put 0% down while others require just 3% down for a conventional loan. But there’s a catch: lenders typically charge a higher interest rate to mitigate their risk, which means you’ll pay more interest over the life of the loan.
When you put down more money, your monthly mortgage payment and your loan-to-value ratio will be lower. The LTV ratio, which divides the loan amount by the home’s value, plays a key role in your mortgage approval. It also helps determine how much money you can borrow from a lender.
You don’t need to put down 20% to buy a home
Maybe you already have a down payment amount in mind. Here’s a look at the minimum requirements of some common loan types.
Conventional mortgage: 3% to 5%
Fannie Mae and Freddie Mac are companies that propel access to U.S. mortgage credit. They don’t lend money but they back programs offered by conventional lenders. These special programs require just 3% down, but they may have income restrictions and more stringent credit requirements.
Lenders require 5% to 15% down for other types of conventional loans. When you get a conventional mortgage with a down payment of less than 20%, you have to get private mortgage insurance, or PMI.
The monthly cost of PMI varies, depending on your credit score, the size of the down payment and the loan amount. Some lenders might waive PMI, but they often charge a higher interest rate to account for the greater risk.
FHA loan: 3.5%
For a mortgage insured by the Federal Housing Administration, the minimum down payment is 3.5%. That means you’ll receive the maximum financing FHA offers at 97.5%, but, you need a FICO score of at least 580.
FHA loans come with upfront mortgage insurance premium (MIP) and annual MIP.
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.
You can make a higher down payment on an FHA loan. To encourage that, the FHA charges lower borrowing costs if your down payment is 5 percent or more. One difference between the FHA and private mortgage insurance is that the FHA doesn’t charge more to people with lower credit scores.
There’s a notable drawback to putting down less than 10% on an FHA loan. When you do this, you cannot cancel annual mortgage insurance premiums. You’ll pay those for the life of the loan or until you refinance or sell.
VA and USDA: 0%
The U.S. Department of Veterans Affairs and the U.S. Department of Agriculture guarantee zero-down payment loans for qualified homebuyers.
With both loan types, you borrow from a regular lender, but the VA or the USDA guarantees the loan. There is no mortgage insurance, but you pay a guarantee fee.
A down payment you can afford
You’re not alone if you’re bewildered by all the down payment options. This is especially true for first-timers who have saved more than the minimum down payment they’re qualified for.
Keep in mind your down payment can consist of your personal savings plus gifts from relatives and grants from local governments or even employers. Cash gifts can’t be loans, and the gift giver needs to write a gift letter to make that clear. A lender will require documentation to source where the funds came from, too.
It’s important to ensure you’re not depleting (or neglecting to fund) your retirement savings account or your emergency fund to buy a home. Doing so could put you at a disadvantage to retire comfortably later on. Draining your emergency fund isn’t ideal because you might need to make costly repairs after moving in or run into a financial hardship, and you won’t have a cushion to fall back on.
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