You’ve likely heard you need a 20% down payment to get a home or you won’t get approved, right?
What if that isn’t the case?
Deciding how much to put down on a home is one of the most important decisions you’ll make when buying a house. Here’s what to consider.
What is a Down Payment?
A down payment is your investment in the home. It’s the money you put down to buy the home. The money comes from your own funds (checking, savings, or investments). It’s not borrowed money from the bank or lender, and you cannot access the money again until you either sell the home or borrow from your home’s equity down the road.
How Does a Down Payment Work?
When you apply for a mortgage, you include in your application how much money you might put down on the home. The amount can range from 0% - 20% or more. There’s no right or wrong down payment.
The money you put down lowers the amount you must borrow. For example, if you offered $200,000 on a home and the seller accepted your offer, the seller needs $200,000 at the closing. You will likely borrow most of the funds, but any money you have to contribute (put down) comes off the amount you borrow.
Let’s say you have $20,000 to put down on the home. This means you borrow $180,000 from the lender and pay $20,000 of your own funds to the seller.
What is the Lowest Down Payment I can Make?
Every loan program has a different minimum house down payment that’s required or the lowest amount you can put down on a home for each program. This doesn’t mean you can’t make a larger down payment, though.
Here’s what each loan requires:
Conventional loans – 3% for first-time buyers and 5% for subsequent homebuyers
FHA loans – 3.5% for buyers with at least a 580-credit score (10% for buyers with a 500 – 579 credit score)
VA loans – No down payment is required for veterans with enough VA entitlement
USDA loans – No down payment is required for families that qualify for this government program
Do I Need a 20% Down Payment?
We talked about the minimum amount you’d need down on a home, but everyone always wonders ‘is a 20% down payment required?’
A 20% down payment is helpful if you’re borrowing a conventional loan. With 20% down, you won’t have to pay private mortgage insurance. This insurance protects the lender in the event that you are unable to make payments.
With 20% down, the risk of a borrower defaulting is much lower, so lenders don’t have to require PMI, which gives you a lower mortgage payment.
But, if you can’t put down 20% or you take out an FHA loan, you’ll have to pay mortgage insurance. It’s not the worst thing in the world, though. Mortgage insurance helps you secure financing when you either don’t have great credit or you don’t have a lot of money to put down on a home.
The Benefits of a Larger Down Payment
If you have the funds available, there are some benefits of making a larger down payment versus the minimum down payment required.
Here are a few ways you can benefit.
- Your Mortgage Payment will be Lower
The less money you have to borrow to buy a house, the lower your mortgage payment will be. A lower mortgage payment makes it easier to budget and ensures that you have sufficient funds each month.
- You’ll Pay Less Interest
When you make a larger down payment, two things happen. You earn instant equity in the home you buy, and lenders may give you a lower interest rate because your loan-to-value ratio is lower with a higher down payment.
A lower interest rate means you’ll pay less interest over the life of the loan, which could save you thousands of dollars just because you invested your own money when you bought the home.
- You Might Avoid Mortgage Insurance
If you borrow a conventional loan, you’ll avoid mortgage insurance if you put down at least 20% on the home. However, if you still need government-backed financing, such as an FHA loan, you’ll pay mortgage insurance for the life of the loan no matter how much money you put down on it.
The Downsides of a Larger Down Payment
Just to be clear, a large down payment isn’t’ right for everyone. There are some reasons you might want to stick to the minimum required down payment including the following.
- It can take a Long Time to Save
If you want to put 20% down, that’s $20,000 for every $100,000 in sales price. That’s a lot harder to save than say $3,000 - $5,000 for every $100,000 in sales price.
- You Might not Have Money for Unexpected Expenses
Owning a house means you’re responsible not only for the mortgage payments but also for the home’s upkeep. What happens if there’s an emergency in the home that costs thousands of dollars to repair but you used up your savings on the down payment? Consider splitting the difference and saving some money for these times.
- It Could be an Opportunity Cost for Other Investments
If you have to cut down or completely cut off other investments, such as for retirement or other important goals, putting a large down payment on a home can be an opportunity cost. Instead of cutting off the investments completely, consider putting less money down so you don’t have to sacrifice.
Before you apply for a mortgage, think about how large of a house down payment you’ll make. If you have ‘bad credit’ or a high debt-to-income ratio, you may want to make up for it with a higher down payment.
If not, you can decide how large of a down payment you want to make to keep your payment affordable, while still ensuring you have enough money for home emergencies, medical emergencies, and other investment opportunities.