For the majority of home buyers, the down payment is the biggest obstacle standing in their way. It can be difficult, or even impossible, to save up so much money.
On top of that, trying to figure out how much of a down payment you need can be overwhelming to say the least.
Most people assume that they need a huge down payment to purchase a home. And while putting down 20 percent can definitely be a good idea, it isn’t always necessary. In fact, depending on the loan you choose, your finances, and the home you’re looking at, you might need much less than you think.
So, if you’re thinking of saving up for a down payment, read on for information that can help you figure out how much you need to put down on a home.
What Is a Down Payment?
Before we dive in, it’s important to talk about what a down payment actually is. Essentially, it’s the cash you pay upfront towards a large purchase. In this case, it’s the money you’re putting towards your home.
When you apply for a mortgage to buy a home, the down payment is expressed as a percentage of the total price. For instance, a 10 percent down payment on a $300,000 house would be $30,000. The lender then provides the rest of the money needed to buy the property.
The more money you put down, the more of the home you technically own. Larger down payments will also lower your mortgage loan balance, which leads to lower monthly payments and less interest paid over the life of your mortgage. In other words, it will save you tons of money in the long run.
Most lenders require a down payment for mortgages — think of it as insurance that you’re good for the money. However, there are a few exceptions, like VA loans and USDA loans. These programs are backed by the federal government and usually do not require down payments from borrowers.
How Much Do You Need for a Down Payment?
Unfortunately, there’s no hard number or exact percentage that you need for a down payment. Your requirements will depend on the type of mortgage, the lender you are working with, and your finances. Your credit history and the price of the home you are looking at will also come into play.
Let’s take a look at some of the different kinds of loans and the minimum down payment requirements typically associated with each of them.
Conventional Loans: Although conventional loans are not backed by the government, most do follow the down payment guidelines set by government-sponsored enterprises, Fannie Mae and Freddie Mac. In general, these have stricter credit requirements, so you’ll need a good credit score and lower debt. But if you’re a first-time homebuyer, it’s possible to get a conventional loan with a down payment as low as 3 percent.
FHA Loans: These are backed by the Federal Housing Administration and require as little as 3.5 percent down. However, your minimum down payment amount will vary based on your credit score.
VA Loans: These loans are for those with VA benefits: active military service members, veterans, and eligible surviving spouses. VA loans are guaranteed by the U.S. Department of Veterans Affairs, and they usually do not require a down payment at all.
USDA Loans: USDA loans are backed by the U.S. Department of Agriculture’s Rural Development Program, and are intended for rural and suburban buyers who meet specific income limits and other requirements. If you qualify, these loans do not have down payment requirements.
Of course, these are just the general minimum requirements. You can often choose how large of a down payment to make, as long as it meets the minimum.
Many people assume that bigger is better when it comes to down payments. As with anything, there are both pros and cons. Let’s look at the benefits of a larger down payment, versus a smaller down payment.
Benefits of a Larger Down Payment
The biggest benefit of putting down a larger down payment is that it will save you plenty of money over the life of your loan. The bigger your down payment, the less you have to borrow from the lender. This means that you will pay less in total interest costs, and you will also have lower monthly payments. If you plan on staying in your home for a long time, this is especially beneficial.
Along with saving you interest and lowering your mortgage payments, larger down payments have other perks, as well:
Lower Interest Rates: By putting down a bigger down payment, you may qualify for a lower interest rate. That large down payment reduces your lender’s risk, which can potentially reduce your interest charges.
No Insurance Required: If you are able to put down 20 percent or more, your lender may not require private mortgage insurance (PMI) and other fees. PMI is designed to protect the lender if you default on the loan. This will save you even more money each month.
Borrowing Power: Lenders love big down payments, and it shows them that you have more than enough income to meet your obligations. That big down payment also reduces your monthly payment, leaving you with a lower debt-to-income ratio. All in all, large down payments will make it easier for you to qualify for additional loans in the future.
Benefits of a Smaller Down Payment
Large down payments aren’t always the best option for home buyers. There are benefits to putting down a smaller down payment, as well.
First and foremost, this is the best (and sometimes only) option for many home buyers. Not all of us have several thousands of dollars saved up to purchase a home. Depending on the price of the home you’re looking at, a 20 percent down payment can be pretty steep! Putting down less money means being able to purchase a home sooner, instead of saving for years — or even decades.
Aside from getting you into a home sooner, there are other perks, too:
Money for Improvements: When you purchase a home, chances are there will be things you want to improve or change. Perhaps the home needs a new roof, or the kitchen needs updating. By putting less of your savings down, you still have cash on hand to knock some of those improvements out.
Emergency Savings: Much like keeping some of your cash for improvements, you might also feel better about keeping some of that money for your emergency fund. Some people aren’t comfortable with tying all of their money into a home, and having nothing stashed in case a car breaks down or health problems arise.
A Word on Zero Down Payment Options
Remember that I said a down payment is like an insurance policy; it proves to the lender that you have the money, and there is less risk that you will default on your loan. However, there are options out there for home buyers who aren’t able to save up a large lump sum for a down payment.
Government-backed loans, such as a VA loan or a USDA loan, don’t require down payments because they are insured by the federal government. With these, the government foots the bill if you stop paying back your mortgage.
The trade-off, though, is that these zero down payment options will cost you more money in the long run. You will wind up with a higher loan balance, a higher interest rate, and a larger monthly payment.
If you have the ability to pay a down payment, I’d advise you not to take advantage of zero down payment options, because you’ll wind up costing yourself more money in the long run. On the flip side, though, if you don’t have the ability to save up that much money, these are definitely the programs that can help you get into home ownership.
Both VA and USDA loans have their own specific set of criteria that you will need to meet in order to qualify. There are also limitations to what you can purchase with them. For instance, you can’t use a VA loan to purchase a “fixer-upper,” investment property, or vacation home. There are geographical restrictions for USDA loans, and you can only purchase single-family homes.
Determining Your Down Payment
As you can see, there is a lot you should consider when determining how much of a down payment you need. Your down payment will depend on your financial situation, the loan you choose, and your overall goals. And while a larger down payment will save you money, putting too much down can leave you strapped for cash.
Before making any financial decisions, it’s always a good idea to talk to a loan officer, a mortgage broker, or a financial advisor. They will be able to talk you through the pros and cons of each option, and help you get started in the right direction.
Don’t settle on the first lender, either. Just like with anything else, shop around! Compare mortgage rates offered by multiple lenders to find the right solution for you.