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When you buy a home, one of the biggest up-front expenses is the down payment. Not to be confused with closing costs, the down payment is the portion of the purchase price that you pay upfront at closing. Generally, if you put less money down on a home at closing, you’ll pay more in fees and interest over the loan’s lifetime (and vice versa).
Key Takeaways
- The down payment you make on your home impacts what kind of mortgage you qualify for, how much money a lender will give you, and the loan’s terms and conditions.
- But the size of your down payment also impacts your lifestyle and long-term financial planning goals, as it determines your monthly mortgage payments and how much money you’ll have for other expenses.
- If you’ve only ever rented, keep in mind that your monthly expenses as an owner include more than just the mortgage; there are also property taxes, maintenance, insurance, and potential repairs.
- A larger down payment will give you a lower loan-to-value ratio, or LTV. This key measure makes you less risky to lenders, may qualify you for lower interest rates, and may help you avoid fees, such as private mortgage insurance.
- A larger down payment may make you more competitive as a buyer because you’ll be seen as more reliable, less prone to haggling, or needing to ask for sellers to pay closing costs.
Understanding Down Payments on Houses
The amount you designate as a down payment helps a lender determine how much money to lend you and which type of mortgage is best for your needs. But how much is just the right amount for a down payment? Paying too little will cost you in interest and fees over time. Too much could deplete your savings or negatively affect your long-term financial health.
Plus, you still need to factor in closing costs, moving expenses, and other monthly bills. Ultimately, the size of your down payment depends on you: your savings, income, and budget for a new home.
First, you need to figure out your budget and how it can impact your down payment. Investopedia’s free, online mortgage calculator helps you calculate your monthly mortgage payments and make the right financial decisions when buying a house. One of the fields asks for an estimated down payment amount.
While a 20% down payment was once the standard, the median average is now 12% for many homebuyers.
How Much House Can You Afford?
When you are pre-approved for a mortgage, a lender will tell you the maximum loan amount for which you qualify, based on responses in your application. Your mortgage application asks about your estimated down payment amount, income, employment, debts, and assets. A lender also pulls your credit report and credit score. All of these factors influence a lender’s decision about whether to lend you money for a home purchase, how much money, and under what terms and conditions.
As a general guideline, many prospective homeowners can afford to mortgage a property that costs between 2 and 2.5 times their gross income. For example, if you earn $100,000 per year, you can afford a house between $200,000 and $250,000.
Rather than simply borrowing the maximum loan amount a lender approves, you’re better served by evaluating your estimated monthly mortgage payment. Say you get approved for a $300,000 loan. If your monthly mortgage payment and other monthly debts exceed 43% of your gross monthly income you might have trouble repaying your loan if times get tight. In other words, be cautious about buying more house than you can reasonably afford.
If you’ve been renting for some time—or you already own a home and are looking to buy again—you likely have a strong handle on the monthly mortgage payment you can afford. Renters should keep in mind that owning a home or condo includes additional expenses such as property taxes, maintenance, insurance, possible Home Owners Association (HOA) dues, and unexpected repairs.
Beyond buying a house, you may also want to contribute to other financial goals such as saving for retirement, starting a family, shoring up an emergency savings fund, and paying down debt. Taking on a too-high monthly mortgage payment will eat up cash that could otherwise go toward some of these important goals.
Down Payment and Your Loan-to-Value Ratio
Your down payment plays a key role in determining your loan-to-value ratio, or LTV. To calculate the LTV ratio, the loan amount is divided by the home’s fair market value as determined by a property appraisal. The larger your down payment, the lower your LTV (and vice versa). Since lenders use LTV to assess borrower risk and price mortgages, a lower LTV means you pay lower interest rates on your mortgage—and may avoid additional costs.
A lower LTV ratio presents less risk to lenders. Why? You’re starting out with more equity in your home, which means you have a higher stake in your property relative to the outstanding loan balance. In short, lenders assume you’ll be less likely to default on your mortgage. If you do fall behind on your mortgage and a lender has to foreclose on your home, they’re more likely to resell it and recoup most of the loan value if the LTV ratio is lower.
In addition to assessing your risk, lenders use the LTV ratio to price your mortgage. If your LTV ratio is lower, you’ll likely receive a lower interest rate. But if the LTV ratio exceeds 80%, meaning you’ve put less than 20% of the home’s value as a down payment, expect higher interest rates. These rates cover the lender’s increased risk of lending you money.
Also, if your LTV ratio exceeds 80%, you’ll likely pay for private mortgage insurance, (PMI). The amount of PMI you’ll pay depends on your loan type. For instance, some loans insured by the Federal Housing Administration require both an up-front mortgage insurance premium that’s paid at closing, as well as an annual mortgage insurance premium (MIP) for the life of the loan. While FHA loans have a low, 3.5% down payment requirement, the total cost of borrowing money as calculated in the annual percentage rate tends to be much higher for these loans.
For loans that will accept down payments of 5% or less, consider Fannie Mae and Freddie Mac, individual lender programs, Government-insured FHA loans, VA loans, or USDA loans.
How Your Down Payment Impacts Your Offers
When you’re on the hunt for the right home, time is of the essence. Homes at entry-level price ranges typically sell quickly, and you want to put your best foot forward when making an offer because you’ll probably have competition. When markets are competitive and sellers receive multiple offers, they want to see buyers’ best offers, including a sizable down payment. From a seller’s viewpoint, buyers who have more money to put down are more attractive because they have more skin in the game.
A higher down payment can indicate to a seller that you have enough cash on hand and solid finances to get a final loan approval (and get to the closing table) without a hitch. Also, a higher down payment could beat out other offers that ask for sellers to pay closing costs or offer below the asking price. Someone with a sizable down payment is unlikely to request such assistance, and sellers are more likely to work with a buyer who has the money and motivation to see the purchase through with minimal haggling.
Benefits of Larger Down Payment
While not always available for a homebuyer, making a larger down payment can be a smart strategy to lower both the monthly cost of carrying the home, as well as the overall cost of interest paid over the lifetime of the loan. This also means that you will have a larger amount of home equity in your house to draw on if you need to access it through a home equity loan or HELOC. This can be helpful if you need to remodel or just need the cash for a large expense or emergency.
In addition to the lower financial costs of owning your home, a larger down payment can also qualify you for a lower interest rate on your mortgage, especially if you can get the loan amount down below the jumbo loan threshold. You also won’t need to pay for PMI mortgage insurance and you may have an advantage over other potential buyers in the case of multiple bids by making a more attractive offer.
While there are benefits to a larger down payment, one must balance the pros and the cons. With a larger amount down, that money is no longer available to make other purchases or investments, so there is an opportunity cost. That money will also be tied up in your home, making it less liquid than cash.
Low Down Payment Loan Programs
The old standard used to be that homebuyers needed 20% down to buy a home. Times have changed. Many homebuyers, especially first-time buyers, simply don’t have a 20% down payment saved. This is becoming increasingly the case as home prices soar in many U.S. housing markets. For example, the median existing-home price in October 2021 was $353,900, a 13.1% increase from $313,000 in October 2020, according to the latest data from the National Association of Realtors.
In fact, homebuyers who financed their home put down an average of 12% of the purchase price, according to NAR’s 2021 Home Buyers and Sellers Generational Trends Report. First-time buyers using financing typically put down just 7% of the purchase price, the survey found.
For those who can’t afford a 20% down payment, several types of mortgages offer a low down payment option.
Conventional Loans
Fannie Mae and Freddie Mac Programs (3% Down)
Fannie Mae and Freddie Mac, government-sponsored enterprises that buy and sell most U.S. mortgages, require only 3% down for borrowers with strong credit. Fannie Mae’s HomeReady mortgage program allows a 97% LTV ratio for borrowers with a minimum credit score of 620.
Freddie Mac’s Home Possible Advantage mortgage also offers a 97% LTV ratio for borrowers but requires a minimum credit score of 660 to qualify. The program will even consider some borrowers with no credit score by building a non-traditional credit report—as long as those borrowers meet certain debt-to-income and loan-to-value ratio guidelines in addition to other requirements.
Individual Lender Programs (1% to 3% Down)
Many lenders offer Fannie Mae and Freddie Mac’s programs and add their own down payment assistance benefit for a conventional loan. For example, Wells Fargo’s Dream. Plan. Home. Mortgage allows for 3% down for borrowers at or above 80% area median income requirements.
This is only one of many options. If you need a loan with a low down payment requirement, ask lenders about their offerings to help you narrow down your choices.
Jumbo Loans (10% to 20% Down)
Jumbo loans are the most common type of non-conforming conventional loan available to homebuyers. Lenders have varying qualifying guidelines for jumbo loans, which exceed an area’s conforming loan limit set by the federal government.
Because jumbo borrowers present more risk for a lender, expect to put 10% to 20% of the purchase price down. Borrowers with credit scores of 700 or higher tend to get the best pricing, but some lenders will work with jumbo borrowers with a minimum score of 660.Lenders might require you to have at least a year’s worth of the home’s purchase price in cash or other assets in case you run into issues repaying your mortgage.
Government-Insured Loans
FHA loans (3.5% down)
You can put as little as 3.5% down on FHA loans if you have a minimum credit score of 580. FHA-approved lenders also will consider borrowers with non-traditional credit histories as long as you’ve had on-time rent payments in the past 12 months, no more than one 30-day late payment to other creditors, and you haven’t had any collection actions (medical bills being the exception) filed in the last 12 months.
Also, the property you’re buying must comply with the property standards set by the U.S. Department of Housing and Urban Development for single-family and condo homes and be within FHA loan limits. Another benefit of FHA loans is that you can use a financial gift from a relative or friend toward all or part of your down payment if you provide documentation stating it’s a gift and not a third-party loan.
VA loans (0% down)
U.S. military service personnel, veterans, and their families can qualify for zero-down loans backed by the U.S. Department of Veteran Affairs. Other benefits include a cap on closing costs (which may be paid by the seller), no broker fees, and no MIP. VA loans do require a “funding fee,” a percentage of the loan amount that helps offset the cost to taxpayers. The funding fee varies depending on your military service category and loan amount.
USDA loans (0% down)
The U.S. Department of Agriculture guarantees loans to help make homeownership possible for low-income buyers in rural areas nationwide. These loans require no money down for qualified borrowers—as long as properties meet the USDA’s eligibility rules.
Down Payment Assistance Programs
Special programs in your state or local housing authority offer help to first-time buyers. Many of these programs are available based on buyers’ income or financial need. These programs, which usually offer assistance in the form of down payment grants, can also help with closing costs. The U.S. Department of Housing and Urban Development lists first-time homebuyer programs by state. Select your state then “Homeownership Assistance” to find the program nearest you.
4 Ways to Save More for a Down Payment
It can be a challenge to save money for a down payment on a home. Here are some quick tips to get you there:
- Start early with an automated plan. In addition to a regular savings or emergency fund account, open a dedicated savings account for your down payment. After each pay period or windfall (like a financial gift, tax refund, bonus, or inheritance), deposit money into your down payment fund and watch the balance grow over time. Contributing to that fund as early and often as possible will help you stay on track.
- Slash your spending. If homeownership is important to you, cut out or reduce unnecessary expenses such as cable and TV service, eating out, vacations, or other non-essentials. By spending less, you’ll save more toward your down payment and have extra money to pay down other debts. Making sacrifices now can go a long way toward achieving your homeownership goals.
- Pay off high-interest debts. Credit cards or loans with high-interest rates can hurt your credit and are costly in the long run. Focus on paying down these accounts first, and you’ll see a snowball effect on reducing your debt. Once these accounts are paid off, you can then apply the monthly payment amounts toward your down payment savings. However, don’t close these accounts; that can lower your credit score because you’re losing an open line of credit and an account history. Instead, use them minimally (buy gas or an occasional dinner at a restaurant ) and pay the balances off immediately. This behavior helps bolster your credit payment history and shows responsible usage to credit bureaus and lenders.
- Get a second job. Many first-time buyers find they can save much faster if they increase their income. Finding side gigs to do from home or working a seasonal retail job can help increase your down payment savings. Even if you work temporarily for six months or a year prior to buying a home, the added income could be the boost you need for a decent down payment.
Example of a Down Payment
The mechanics behind making a down payment are fairly straightforward. Imagine you find a house for sale, and you have an accepted offer to buy it for $500,000 with a 20% down payment. The down payment amount would be $100,000 = (500,000 x 0.20). This sum of money must be deposited in a timely manner into an escrow account that will be held until closing. At closing, it will be credited toward the final amount due.
Do I Need To Put 20% Down on a House?
No. The old standard was 20% down to buy property, but the majority of first-time homebuyers put 7% or less down on a home, according to a National Association of Realtors survey.
What Is the Minimum Down Payment on a House?
There is no law or rule for a universal minimum down payment, but the more you pay upfront, the lower your monthly mortgage payments, the lower the interest rate you will qualify for, and the less likely you will be to have to pay mortgage insurance or other fees. Generally, however, 3%-5% would be the absolute minimum, and only for certain borrowers.
Is It Better To Put a Large Down Payment on a House?
If you can afford to put a sizeable down payment on a property, the benefits include more options for a mortgage, lower interest rates, more negotiating power with a seller, and the avoidance of having to pay mortgage insurance and certain other fees. But if putting a large down payment would result in you not having enough money for other monthly expenses or your long-term savings goals, a smaller down payment may make more sense.
How Much Money Do I Need To Buy a House for the First Time?
As of October 2021, the median home price in the U.S. is around $404,700. Assuming a 20% down payment, you would need $80,940 for a down payment, plus several thousand more for closing costs and fees to your lender, realtor, lawyer, and title company. Still, no set amount is required and home prices vary state-to-state and city-to-city. It’s all dependent on what you’re looking for in terms of size and type of property, neighborhood, amenities, and any other details specific to your situation.
The Bottom Line
It’s not impossible to buy a home if you don’t have much cash saved up for a down payment. Shopping around for the right lender and loan type is a critical step. With a lower down payment, expect to pay higher loan fees and interest rates, as well as PMI. Also, don’t forget to tap into down payment assistance programs offered by your state or city. If someone offers a financial gift toward your down payment, make sure they understand it cannot be a loan.
There’s no shortcut to saving for a down payment: It takes time, discipline, and effort. But the result—purchasing a home of your own—can be rewarding, both financially and personally.
