What is a down payment?
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Most homebuyers have to pay a portion of the property’s purchase price upfront. This amount is called a down payment. Exactly how much you’ll need to put down hinges on several factors beyond just the price of the home. Here’s what to know.
What is a down payment on a house?
A home down payment is the part of a home’s purchase price that you pay upfront and does not come from a mortgage lender via a loan.There are many ways to come up with a down payment to buy a home. For repeat buyers who have positive equity in their current home, it’s often the proceeds from selling that home that helps make a down payment on another one. Other sources include:
- Selling assets like cars, collectibles, crypto, mutual funds or stocks
- Borrowing against a 401(k) retirement plan
- Down payment assistance (DPA) programs from employers, nonprofit organizations and government agencies
- Gifts from family members and friends (28 percent of first-time buyers used gift funds to help cover part of their down payments in 2021, according to NAR)
Some down payment sources, however, are not allowed by lenders. These include loans or gifts from anyone who would benefit from the transaction, such as the home seller, real estate agent or lender.
How do down payments work?
Suppose you want to buy a house priced at $300,000. If you were to put $9,000 toward the purchase price, or 3 percent down, you’d take out a mortgage for the remaining $291,000. If you were to put down $60,000, your down payment would equal 20 percent of the purchase price, and your loan would be for $240,000.
Mortgage lenders often refer to the percentage of the purchase price that they finance as the loan-to-value ratio, or LTV. Using the above examples, here’s how that looks:
- When you put $9,000 down (3 percent) on a $300,000 home, your LTV ratio is 97 percent.
- When you put $60,000 down (20 percent) on a $300,000 home, your LTV ratio is 80 percent.
Who gets the down payment on a house?
As the homebuyer, your down payment goes into an escrow account, often managed by a real estate attorney or settlement officer. This third party holds onto the funds and distributes them to the seller once the deal is finalized. The seller ultimately receives the down payment.
How to choose the best down payment amount
Putting a large down payment comes with plenty of perks, but it’s not necessarily the best decision for every homebuyer. Consider these pros and cons:
Benefits of a bigger down payment
- Smaller monthly payments: Making a bigger down payment upfront translates to smaller mortgage payments each month. Consider the difference between 3 percent down and 20 percent down on a $400,000 home. With a 30-year loan at a fixed 6 percent interest rate, Bankrate’s down payment calculator shows that the bigger down payment translates to a monthly mortgage payment savings of around $400.
- Lower lifetime interest charges: Those smaller monthly payments add up to significant savings in the long run. In that $400,000 home example, a 20 percent down payment would save more than $78,000 over the course of a 30-year mortgage.
- Potentially better terms: Lenders like to see larger down payments. By putting more of your own money into the transaction, you’re borrowing less of theirs, which can put you in the running for the lowest rates possible.
- Ability to skip PMI: If your down payment is 20 percent on a conventional loan, you won’t have to deal with the additional monthly fee of mortgage insurance.
Drawbacks of a bigger down payment
- Potential to stretch your savings too thin: If you’re draining nearly all your savings to make a bigger down payment, you’re putting yourself in a precarious position as a new homeowner. What happens if you need to cover an emergency cost?
- The need for more time to save: You might be tempted to keep saving up money to make a bigger down payment, but that strategy can backfire. While you’re trying to cut every expense, home prices might still be rising at a pace you can’t keep up with.
Bigger vs. smaller down payment example
A bigger down payment can make it easier for you to get approved for a mortgage and allow you to buy more house for the same monthly payment, or even less. You might also get a lower rate and lower mortgage insurance premiums (if any). Here’s a breakdown of a 30-year, $375,000 mortgage with a 6.5 percent interest rate, using data from Bankrate’s mortgage calculator and mortgage insurance estimates from Freddie Mac’s PMI calculator:
|Home price||Down payment||Monthly principal and interest||Monthly PMI||Total monthly payment|
Note this example doesn’t account for the interest rate savings you’d likely see if you were to make a larger down payment. With 20 percent down, for example, you might pay a lower rate compared to the rate you’d get with 10 percent down.
Keep in mind, as well: There is a trade-off between your down payment and credit rating. Bigger down payments can offset (to some extent) a lower credit score; higher credit scores can offset (to some extent) a lower down payment. It’s a balancing act.
For many first-time buyers, the down payment is the biggest obstacle to homeownership. That’s why they often turn to loans with smaller minimum down payments. Many of these loans, though, require borrowers to purchase some form of mortgage insurance.
However, mortgage insurance is not necessarily a bad thing if it gets you into a home and starts you on the road to building equity. Consider this: If you were to save $250 a month, it would take you 25 years to accumulate the $75,000 needed for a 20 percent down payment on a $375,000 home. That’s a long time to keep renting just to save up the money. Plus, by the time that 25-year period is up, that $375,000 house is going to cost a lot more.
What is the minimum down payment on a house?
The minimum down payment on a house depends on the mortgage program, the type of property you buy and the price of the home. In some cases, you might be eligible for a loan that doesn’t actually require a down payment at all.
Most conventional loans allow for as little as 3 percent of the purchase price if you have great credit. FHA loans require a small down payment as well: just 3.5 percent.
There are two government-backed loan programs that don’t have a down payment requirement: VA loans for service members and veterans and USDA loans for eligible buyers in rural areas.
Why mortgage lenders require a down payment
Very few mortgage programs allow 100-percent, or zero-down, financing. That’s because a down payment on a home reduces the risk to the lender in several ways:
- Homeowners with their own money invested are less likely to default (stop paying) on their mortgages.
- If the lender has to foreclose and sell the property, it’s not on the hook for the entire purchase price, which can limit its potential losses if the home is sold for less than the remaining mortgage balance.
- Saving a down payment requires discipline and budgeting. This can help set up borrowers to be successful homeowners.
Why down payments are good for homebuyers
That initial down payment might feel like a huge obstacle standing in your way, but saving for a down payment provides good practice for the financial responsibilities of homeownership.
Suppose you currently rent for $800 per month, and the payment for the home you want to buy would be $1,200 per month. You can “practice” for homeownership by putting the $400 difference into savings. This accomplishes three things:
- Your down payment savings grows.
- You’ll get used to having less spending money.
- You might avoid an expensive mistake if you realize you can’t handle the larger payment.
Many financial experts agree that having a down payment is a good sign you’re ready for homeownership. If you can make the necessary sacrifices to amass a down payment, then you’ll likely be able to manage expenses that come with owning a home, including monthly mortgage payments, homeowners insurance and maintenance, repairs, property taxes, HOA dues and utilities.
Plus, a larger down payment can also help you win a bid for a home against other buyers. By reducing uncertainty about whether the transaction can go through, the higher down payment makes your offer more competitive.
Bottom line on down payments
The size of your mortgage down payment is a personal and practical decision. Take a holistic look at your monthly budget, debts and cost of living in your city. Bankrate’s affordability calculator can help you determine the right amount for you, and so can a trusted mortgage professional. Ultimately, the decision comes down to your desire, discipline and resources.