Among the costs you have to consider when buying a home, the down payment stands out as it can be a significant amount of money. Whether you use your saved funds or seek the money from another source, the down payment helps you meet the requirements for certain mortgage loan programs and will lower the amount of money you need to borrow for your home purchase. The down payment you can afford matters since it affects everything from your potential interest rate to your loan program options. Use this guide to better understand down payments, common requirements for loan programs and ways to prepare for the cost.
Basics of a Down Payment
Similar to how you might have paid some money upfront when applying for a car loan, you can agree to pay upfront a percentage of your home loan amount in the form of a down payment. Lenders often require down payments since the upfront money helps reduce some of the risk they take on when offering you a mortgage. The action shows that you've obtained some funding to help lower the loan amount and offers some assurance that your financial situation allows for making timely mortgage payments.
When you make a down payment, the money helps you build equity in your property from the start and thus lowers your loan-to-value (LTV) ratio, which you can calculate by dividing the loan balance by the home's appraised value. For example, if you've already paid $20,000 toward a $200,000 home, then you'd have 10 percent equity or a 90 percent LTV ratio. In addition to helping you have a better financial position, having some home equity can help you later if you ever need to borrow funds through a home equity loan to make improvements to your property.
Typical Down Payment Amount
When looking into down payment requirements, you'll find that they will depend on the specific loan program and even your credit score in some cases. For example, some mortgage programs backed by the government don't require a down payment for most borrowers, but lenders might ask for one if the borrower has a weakness in one of the other requirements. Otherwise, the amount you might put down on a home can range from 3 percent to 20 percent of the loan amount you're taking out. That doesn't necessarily mean all that money has to come from your funds, though, since there are often down payment assistance and gifting programs available.
Keep in mind that making a 20 percent down payment is a common rule of thumb since it offers some advantages that can save you money in the long run. Many mortgage programs require paying private mortgage insurance (PMI) or a similar fee for borrowers who make down payments below 20 percent as a way to protect the lender against added risk. You may either have to pay this until you've achieved 20 percent equity in the property or until you refinance or pay off the loan. PMI can especially add up as some mortgage programs not only charge it monthly as part of your mortgage payment but add on an upfront premium, too.
Read More: Is PMI Tax Deductible?
Making the highest down payment possible can also help you secure a lower interest rate for further savings since lenders often increment your rate based on the down payment amount. For example, you might start seeing better reductions to your rate with a 10 percent down payment than with a 5 percent one. Also, keep in mind that the more money you put down at the beginning, the lower the home loan you need to take out. The lower principal helps you have a more manageable monthly mortgage payment and reduce interest as well.
Mortgages Without a Down Payment
If you'd rather not make a down payment to get a mortgage, you can consider two government-backed options through the U.S. Department of Agriculture (USDA) and the U.S. Department of Veterans Affairs (VA). Both programs target specific homebuyers.
Through the USDA's guaranteed loan programs for single-family housing, you can buy a property in an area the organization considers as rural, as well as have the opportunity to get additional funds to improve an existing property or even build a home. As long as the home sale price doesn't exceed its value, you won't have to contribute a down payment, but all borrowers have to make no more than 115 percent of the rural area's median income for a household. The benefit of no down payment comes with upfront and annual guarantee fees to pay.
Allowing for much more diversity in where you can find a property, VA loans come with the restriction that only qualified people affiliated with the military – such as vets, current service members and their qualified spouses – can take advantage of the option. As with USDA loans, these loans don't require a down payment unless the value's lower than the loan amount, and you can upgrade, buy or build properties. This option doesn't have income limits like USDA loans and just has one upfront funding fee rather than ongoing fees.
Mortgages With Low Down Payments
A government-backed FHA loan comes with a down payment of either 3.5 percent or 10 percent. You'll need your credit score to meet or exceed 580 for the lower amount; otherwise, you can put down 10 percent and qualify with a minimum 500 score. These loans don't have income requirements and can offer a low down payment solution to people with subpar credit, but both upfront and annual mortgage insurance premiums apply. Special FHA program options exist to improve a home you buy or build a new one as well.
Although minimum down payment amounts vary by lender, a conventional loan can come with as low as a 3 percent minimum down payment, with 5 percent being another common option. These loans differ in that they have no government backing, so you can expect stricter credit requirements to qualify, but you also have a lot of flexibility in qualified properties. A conventional loan with a low down payment will require ongoing PMI premiums until you meet the criteria for removing the fee. However, certain income-based programs like Freddie Mac Home Possible can offer lower PMI rates that help first-time homebuyers better afford a home.
Mortgages With Higher Down Payments
In most cases, one of the mortgage programs discussed will fit your needs unless you intend to buy a property that's considered high cost in your location. That's because mortgage programs set maximum loan limits based on locale, and if the property exceeds that price, you'll need to look into getting a jumbo loan. Due to the high amount of money borrowed, you can expect to need a 20 percent down payment to get this kind of loan. Also, you can expect higher requirements for income and credit scores.
Determining the Right Down Payment
To decide how much money you should put down on your next home, you should consider which of the loan programs you plan to use and then use the minimum down payment percentage required as a starting point. You should then consider your target home price to know the loan amount you'd need. For example, if you took out an FHA loan and qualified for the 3.5 percent down payment and wanted to buy a $250,000 home, then your minimum down payment amount would be $8,750. On the other hand, you'd need to do no calculation at all if you went with USDA or VA loans.
With the minimum down payment in mind, you should consider your financial situation and weigh the pros and cons of making an even higher down payment. If you have a considerable amount of savings, you may opt for a 20 percent down payment anyway with a conventional mortgage and benefit from the initial equity, lower interest rate and avoidance of PMI. If you're in a tighter financial situation, you might decide a low down payment fits your needs as long as you're willing to pay any required PMI or fee, get potentially higher mortgage rates and wait longer to build equity.
Testing out some numbers with a down payment calculator can help you see how different down payment amounts would affect the interest and PMI paid over the course of your mortgage or the estimated time you'll keep the property. You can plug in different down payment and loan amounts as well as estimated interest rates and origination fees to run through various scenarios. You can also talk to a lender who can provide you with more personalized advice after you provide some basic financial information and details about your goals.
Read More: Buying a House for the First Time
Considering Ways to Get Funds
Once you know how much of a down payment you need for the loan program that appeals to you, consider the various ways you can acquire the funds needed. Here are some common options you have:
- Use your own savings: As long as you've saved money for a while and have enough for the down payment and a comfortable cushion for an emergency fund, you might already be set. If not, you can delay your home purchase for a while, take the down payment amount needed and come up with a way to save up the money. You can find ways to reduce expenses in your budget or boost your income and then either stash away money from each paycheck or on another schedule that you prefer. For better results, save the money in an account like a certificate of deposit so you can get better interest rates on it.
- Get money through a gift: Depending on your lender and loan program, gifted funds might work as a way to help you meet down payment requirements. You might be able to have the whole down payment gifted as long as you pay your closing costs, or the lender might allow a partially gifted down payment. Keep in mind that the money usually has to come from a family member or close friend, and each program names qualified relationships.
- Use a down payment assistance program: Most states and some private organizations have down payment assistance programs that usually require meeting income guidelines and sometimes only allow first-time homebuyers. You'll find grants with no repayment requirements, down payment loans you repay after a deferment period and forgivable loans that come with certain conditions. Be prepared to work with specific lenders or choose from specific mortgage programs to qualify.
Knowing Other Lender Requirements
Having the right down payment gives you a good start when you start the process of looking for a mortgage and home, but keep in mind this alone won't qualify you for a home loan. Here are some other things to think about as you research:
- Income requirements: Lenders will want to check that your income is stable, and this can mean showing pay stubs or tax returns from the last two years. Your income will also need to be sufficient to pay the mortgage plus all your other debts, so lenders look at your debt-to-income ratio by dividing your monthly income by your monthly debts. A rule of thumb is that the ratio shouldn't exceed 43 percent.
- Credit score: Your loan program and lender determine the minimum acceptable credit score. Unless you have a score of 620 or more, you'll likely need to go with an FHA loan. While the USDA and VA programs don't have program minimums, lenders usually set the minimums between 620 and 640. Jumbo loans can require an even higher credit score closer to 700.
- LTV ratio: Unless you're getting a special loan for rehabilitation, you usually can't take out a loan for more than the appraised home value. You'd need to pay the difference to qualify.
- Closing costs: Beyond the cash for the down payment, you'll need another amount ranging from 2 to 5 percent of the loan for your closing costs. You can get help for this through a state assistance program, discuss rolling them into the loan or consider asking the home's seller to contribute.
To learn more about your likelihood of getting a mortgage, consider reaching out to a lender who can help you with the prequalification process, discuss loan programs in more detail and assess your financial situation and eligibility.
- Consumer Financial Protection Bureau: Determine Your Down Payment
- Consumer Financial Protection Bureau: What Is Private Mortgage Insurance?
- Freddie Mac: Down Payments & PMI
- U.S. Department of Agriculture: Single Family Housing Guaranteed Loan Program
- U.S. Department of Veterans Affairs: Purchase Loan
- U.S. Department of Housing and Urban Development: Let FHA Loans Help You
- Consumer Financial Protection Bureau: Conventional Loans
- Consumer Financial Protection Bureau: What Is a Jumbo Loan?
- Consumer Financial Protection Bureau: Determining How Down Payments Affect Loans
- U.S. Bank: Down Payment Calculator
- Cherry Creek Mortgage: Mortgage Down Payment Gift Rules: What You Should Know
- Georgia Department of Community Affairs: Homebuyers
- Consumer Financial Protection Bureau: What Is a Debt-To-Income Ratio? Why Is the 43% Debt-To-Income Ratio Important?
- Consumer Financial Protection Bureau: What Fees or Charges Are Paid When Closing on a Mortgage and Who Pays Them?
Ashley Donohoe has written about business and technology topics since 2010. Having a Master of Business Administration degree, bookkeeping certification and experience running a small business and doing tax returns, she is knowledgeable about the tax issues individuals and businesses face. Other places featuring her business writing include Zacks, JobHero, LoveToKnow, Bizfluent, Chron and Study.com.