For many, the homebuying journey often begins with a big step - beginning to save for a down payment. How much money will you need? How does the money I put down impact my monthly mortgage payment? How do you even get started saving for a big goal like a down payment? Read on for answers to these questions and more.
What is a down payment for a mortgage?
A down payment is a lump sum of money paid upfront when you buy a home. Down payments are typically expressed as a percentage of the purchase price of a home (example: a 3%, 10% or 20% down payment). So if a home is selling for $200,000, a 3% down payment would be $6,000. The remaining chunk of the home’s purchase price is then financed through a mortgage.
If you are buying a home, chances are a down payment will be required as part of the sale, but that’s not always true. There are certain types of mortgages that do not require a down payment, including those guaranteed by the Department of Veterans Affairs or the USDA Rural Development program, which we’ll discuss in a bit.
Why do I need a down payment?
Depending on the type of loan, a minimum down payment may be a lender requirement, or in many cases, one created by the federal government or regulatory agency. Lenders view down payments as a type of insurance. When a borrower has an investment in a home, they are more likely to pay back the loan.
Most mortgage loans underwritten in the U.S. conform to certain financial standards set by Fannie Mae and Freddie Mac, including things like the size of a down payment, minimum credit scores, and other financial benchmarks. These companies are government-backed, privately held corporations originally created by Congress that purchase many of the country’s mortgages from lenders. The purpose of which is to provide liquidity to mortgage lenders to then go back and underwrite more home purchases. Those standards
Is a 20% down payment required to buy a home?
The short answer is no. 20 percent down payments are not required, particularly for first-time homebuyers. We’ll discuss this in more detail below, but most conventional mortgages in the U.S., which are by far the most common type of mortgage, require just a 3 percent down payment. Some mortgage loans require no down payment at all.
That said, there are many reasons you might want to consider making a larger down payment than what is required. Some of those reasons are:
- Avoiding private mortgage insurance (PMI)
- Access to lower mortgage interest rates
- Lowering your monthly payment by decreasing the loan principal
- Decreasing the overall cost of financing your home
- Improving the quality of your offer in the eyes of a seller
- Putting instant equity into your home
What is private mortgage insurance?
Private mortgage insurance, or PMI, is a type of mortgage insurance that protects lenders in the event of a non-payment on a conventional loan. Lenders will add PMI to your monthly mortgage payment until the equity in your home exceeds the 20% threshold. There are other ways to eliminate PMI payments, including reassessing the value of your home if it has become more valuable, or making lump sum payments, but it’s important to understand that PMI does add cost to home purchases by adding to your monthly payment.
How the type of mortgage impacts a down payment
Depending on the type of loan you select, there are different standards that will apply to your down payment. Here’s a quick breakdown of loan types and their typical down payments.
Conventional Loan | 3% Minimum
Conventional loans are the most common type of mortgage in the U.S. Minimum down payments are set by lenders, with standard guidelines from Fannie Mae and Freddie Mac.
FHA Loan | 3.5% Minimum
FHA loans are insured by the government and issued by approved lenders. Regulators set the minimum down payment requirements. They can be popular with first-time homebuyers who need more flexible lending terms.
VA Loan | No Minimum Down Payment
VA loans are backed by the US Department of Veterans Affairs and issued through approved lenders for qualified service members and their families.
USDA Loan | No Minimum Down Payment
USDA loans are backed by the US Department of Agriculture and issued by private lenders only in qualified rural or suburban areas.
How much should I put down on a home?
The size of your down payment will depend on a number of factors, but ultimately it comes down to your personal financial situation and the specific requirements of a loan. You should consider how much cash you can reasonably access and consider potential expenses of homeownership, both the expected and unexpected.
You should also consider how different down payment percentages would impact your monthly payment amounts. Larger down payments will decrease the principal of a loan, effectively lowering your monthly payment for the remainder of your mortgage. Because a higher down payment can also help you avoid expenses like PMI and help you claim better interest rates, that can further lower your payment.
In the end, there are many reasons a homebuyer may choose to pay a minimum down payment, even if it means paying PMI or paying a higher rate.
- Time - it can take a long time to save up for a 20 percent down payment. You may be able to buy a home months, if not years, earlier with a minimum down payment.
- Budgeting - you don’t want to sacrifice your fiscal health just to maximize your down payment. There are lots of expenses to consider when buying a home and you should budget accordingly.
How do people save for a down payment?
Saving up thousands of dollars for a down payment can seem intimidating for many first-time homebuyers, particularly when purchasing a home in a high-cost of living area with rising home values. But everyone starts somewhere, and even relatively small steps can make a big impact over time if you start to make a plan to buy a home. Here are some ways people begin to save for a down payment:
- Get a Budget - You should know the basics of how much money you have going in and out each month. What are your biggest spending categories? How much of your money is going toward fixed expenses, like rent or utilities? How much is going toward discretionary spending, like dining or entertainment? Once you have that information, you can begin to see areas where you can generate savings and start to accumulate cash.
- Start Early and Start Small - Saving for a down payment can take years, but the sooner you start the longer runway you have to save.
- Make Money Work for You - Once you begin saving, you’ll want a place to store your cash. High-yield savings accounts or certificates of deposit can be great for this because they allow you to earn interest on your money while also being relatively safe stores of money which can help you grow that nest egg faster.
- Understand the Total Cost - The down payment is one piece of the real estate price puzzle, but there are other home buying costs to consider. Closing costs, moving costs, buying appliances and furniture for your new home, it adds up. Not to mention you’ll be paying off your new mortgage loan Better understanding your costs will help inform your ultimate budget.
- Assistance Programs - There are a variety of programs from lenders, as well as the state and federal government that provide down payment assistance if you qualify. Low-interest and deferred payment loans, as well as grants and other forms of assistance can offer a huge boost to your savings.
It can be intimidating to save up for one of life’s most expensive purchases, but with a plan and understanding of your finances in place, you can make the right decision for your personal circumstances.
The information provided here is for informational purposes. When interest rates and loan program information are included, it is for illustration purposes only and not a solicitation or quote for services. This is not an advertisement or loan estimate. Current interest rates, loan programs and qualification criteria can change at any time. If you have questions or need assistance, we can be reached using the contact information above.
