How Much Should You Set Aside for A Minimum Down Payment for a House?

What’s a down payment, and how much is a minimum down payment for a house? You might be familiar with the concept of a down payment if you’ve bought a car before. But a mortgage down payment is unlike other down payments you might have encountered.

A down payment is the amount of money that you pay upfront when buying a home. The rest of the purchase price comes from your lender in the form of a mortgage. Most (but not all) home purchases involve down payments.

Some buyers pay cash, so there’s no mortgage, and therefore no down payment. Some buyers finance the entire purchase with a zero-down-payment loan, so there’s no down payment.

Curiosity may be the most common trait when it comes to homebuyers and down payments.

Richie Helali, mortgage sales leader at HomeLight, says down payments are in the conversation daily when he is talking to prospective borrowers. And if they don’t bring it up, he often does.

“A question about down payment is normally one of the first questions I’ll ask a client,” Helali says. “It’s on almost every single phone call.”

What’s a down payment?

It’s not always clear to a first-time buyer exactly what the down payment is for. Essentially, the down payment is to show lenders that you have a stake in the investment, and something to lose if you don’t hold up your end of the deal. When a buyer has contributed a sizable sum to the purchase of the house, the loan is seen as less risky by the lender.

Indeed, real estate history has shown that buyers who have little to no skin in the game are more likely to walk away from a mortgage if the housing market goes south, their employment situation gets shaky, or some other important factor changes in the future and makes it difficult for them to make a payment.

A down payment helps convert someone who is merely a borrower into someone who is part owner of an asset and therefore who is less likely to default on the loan and risk losing that asset through foreclosure.

Loan-to-value, explained

One of the key concepts around down payments is loan-to-value (LTV) ratio. This figure, usually expressed as a percentage, shows how much money the lender has put up for the home compared to its value. If the home is worth $300,000 and you get a home loan for $270,000, then the LTV is 90%.

Lenders tend to want a lower LTV number. And, from the buyer’s perspective, the less risk there is in the loan, the more likely the buyer is to get a good interest rate and other favorable terms.

“The higher down payment you place, the lower the risk is for the bank,” Helali says.

“Lower risk translates to better terms and interest rates for the buyer.”

The happy place for LTV for most lenders is 80%. That’s when a buyer is likely to get the best deal. In other words, you’ll need to put 20% down on the home’s purchase price.

Here’s how to see if the down payment you have in mind is going to get you there.

To figure LTV, divide the amount of the down payment by the total purchase price of the house. Then express this result as a percentage. Now, subtract that number from 100. The result is your LTV.

For instance, to figure LTV on a $200,000 house with a $40,000 down payment, divide 40,000 by 200,000. The result is 0.2. Expressed as a percentage, that’s 20%. Subtracting 20% percent from 100% gives you 80%. This deal will have an LTV of 80%, which is a good place to target for a buyer.

Mortgage insurance

Having a 20% down payment is not the only way to ease a lender’s worries about repayment. Another financial factor called mortgage insurance can also help.

Mortgage insurance is intended to help the lender avoid financial loss in case the borrower doesn’t repay the loan. Although it benefits the lender, the borrower is the one who pays the premiums on mortgage insurance.

For most loans, if you don’t put at least 20% down, then you will have to pay for mortgage insurance.

“Whenever somebody is making a down payment of less than 20%, regardless of the person’s credit score or creditworthiness, that person is going to be five times more likely to eventually be foreclosed on versus somebody who’s putting 20% down,” Helali explains. “For the bank to mitigate risk, they require somebody putting less than 20% down to have mortgage insurance.”

Mortgage insurance isn’t necessarily forever if you’re using a conventional loan. Once LTV has declined to 80%, due to appreciation increasing the home’s value or the borrower making enough payments to reduce the loan principal sufficiently, the borrower can usually stop paying mortgage insurance.

However, this may take years, and meanwhile, the payments can be a burden. Mortgage insurance premiums usually come to between 0.5% and 1% of the loan amount each year. So on a $200,000 loan, if mortgage insurance was 1%, that would come to $2,000 per year.

These premiums are usually paid monthly as part of your mortgage payment, so in this example mortgage insurance would add $166.67 to the monthly payment. Clearly, putting 20% down can make a difference when it comes to affordability.

Do you really need 20% down?

So we’ve learned that 20% down pleases the lender, makes it more likely you’ll get a good rate, and can help you avoid mortgage insurance. But do you have to have it?

The answer is: Not at all. In fact, while you might have heard that 20% is the typical or even required down payment, reality is very different.

Most buyers, it turns out, don’t put 20% down. Lodestar Software Solutions tallied up 2019 figures and found that the average buyer put down just 5.3%. The National Association of Realtors reported in 2020 that first-time buyers who financed their homes put down an average of 7%. People using a mortgage to buy a second or later home averaged 12% down in 2020, according to NAR.

The difference, Helali says, is due to the value borrowers have accumulated through previous homeownership. “Typically, a first-time homebuyer won’t have 20% down,” he says. “They’ll move forward with whatever they’re comfortable with, like 5%. If they are not a first-time homebuyer, they may have some equity, and they’ll take some of that equity, if not all of it, and put that toward the home.”

Is making a large down payment worth it?

The fact that you don’t have to put down 20% doesn’t mean you should make the smallest down payment possible. And the fact that you can put down 20% — or more — doesn’t mean that’s necessarily the way to go either. Making the decision of how much to put down is basically a matter of examining the pros and cons and fitting the eventual decision to the facts of the specific situation.

Here are some of the advantages of making a larger down payment:

• You’ll get better mortgage terms, including lower interest rates and fees.
• You won’t have to pay mortgage insurance, as long as you’re putting at least 20% down.
• Sellers will prefer your offer over similarly priced other offers in a competitive bidding situation.
• You’ll have more equity in your home.
• Your monthly payments will be lower, especially if you avoid mortgage insurance.

And here are some disadvantages of making a larger down payment:

• You will have less cash to cover expenses for moving, repairs and closing costs.
• Saving up a 20% down payment could take years, delaying your home purchase.
• Instead of paying rent, you could be building equity by paying down your loan balance.
• If local housing prices market rise, you will miss out on the appreciation.
• You may be able to invest the cash elsewhere and get a better return.

How low can you go?

Now that we’ve looked at typical down payments and reasons for putting down more as well as less, let’s consider the minimum down payment you can make on a home. It’s surprisingly low.

Here are minimum down payment requirements for the major types of mortgage loans.

FHA loans

FHA loans, insured by the Federal Housing Administration, offer down payments as low as 3.5% for buyers with good credit who meet some other restrictions. Low-down-payment buyers will have to buy mortgage insurance for FHA loans.

If you put down 10% or more on your FHA loan, then your mortgage insurance will disappear when you reach 20% equity in your home. If you put down less than 10%, you’ll carry that mortgage insurance through the lifetime of the loan.

Conventional loans

Conventional loans may allow as little as 3% down for well-qualified first-time homebuyers. These are loans that are not backed by any government agencies, such as the FHA, but are offered by many lenders and then ultimately sold to either Fannie Mae or Freddie Mac.

Non-first-time homebuyers and slightly-less qualified buyers can also usually get a conventional loan with as little as 5% down. Borrowers putting down less than 20% have to carry mortgage insurance on the loan.

Fannie Mae HomeReady loans

Fannie Mae HomeReady is a special loan program for certain qualified borrowers where you can put as little as 3% down. If you qualify for the program, you may have to take a Homeowners’ Education Course (for first-time homebuyers), and you will be required to pay for mortgage insurance.

VA loans

VA loans for enlisted members of the military, veterans, or surviving spouses can be gotten with no down payment at all. And there’s no mortgage insurance, although there is a one-time VA funding fee for all VA loans.

USDA loans

USDA loan programs also offer zero-down mortgages. These loans are only available for properties and buyers in areas that meet geographical and income restrictions.

Down payment help when you need it

In addition to these sources for low-down loans, there are many more places you can get help coming up with a down payment.

Literally thousands of down payment assistance programs operate in nearly every city and town. They are sponsored by a nearly equal number of different federal, state, and local government agencies, plus a slew of nonprofit organizations. Each of them has its own requirements for down payment assistance. However, they generally favor first-time homebuyers.

Down payment assistance can take the form of a grant that doesn’t have to be paid back, a loan that does have to be paid back, or a forgivable loan that may not have to be paid back if the borrower lives in the home and faithfully makes payments for a few years.

The key thing to remember is that people who use down payment assistance typically save nearly $18,000 on their home purchase. So these programs are well worth looking into. A well-informed real estate agent or loan officer can help steer you in the right direction.

While coming up with a down payment may seem like a big obstacle, in reality it is not necessarily as daunting as it seems. Down payments aren’t as large or as hard to come up with as many people may think. But mastering the down payment is one major key to owning a home. And that’s a puzzle worth figuring out.

“One of the easiest ways to build wealth is through real estate,” Helali reminds readers. “Finding out what you can afford and making that initial investment is a great way to get started.”

Header Image Source: (Jorge Salvador / Unsplash)