How much is a down payment on a house?

If you’ve ever purchased a house before, you know just how unsettling it can be to hand over such a large sum of money for a down payment. If you’ve never owned a home before, get ready to kiss all of those long months of saving goodbye.

But why is a down payment important, and more importantly, how much should you put down on your house? To answer this question, first we need to address a few important factors.

What is a down payment?

A down payment is the amount of money you bring the the table when you close your loan, which bridges the gap between the sale price of the property and the loan amount you are financing.

A lender wants to see a down payment because it shows them that you have “skin in the game”, so to speak, and except for a very limited number of programs*, they’re almost always going to want to see some type of down payment. The more you put down, the lower your interest rate will be since the lender is taking on less risk.

If you are purchasing a property worth $200,000 and you have $20,000 saved away for a down payment, you have a 10% down payment on the house, and your actual loan would be for $180,000. If you saved $40,000, you would have a 20% down payment and your loan would be $160,000.

How much should you put down?

The answer to this question is really more of a personal one. If you’ve carefully been saving for the purchase, owe very little debt, and have an emergency fund saved away as well, by all means put as much down as you possibly can.

Doing so will save you a tremendous amount of interest long-term and lower your monthly payment for the duration of the loan. You’ll also be rewarded with a much lower interest rate.

If you’re in a situation where you’re ready to buy but don’t have much saved, you may want to consider doing the following before you move forward:

1. Establish an emergency fund large enough to cover at least 3 to 6 months of your living expenses plus necessary improvements. You need to consider you will have to pay principle, interest, taxes, and insurance on your house, and a sudden loss of income could make it very difficult to sustain the new payment with your other recurring expenses. In addition, the house may need minor repairs or furnishing. This is an expensive task and paying for it with credit cards only adds to the amount of interest you’re going to pay and could make it harder to sustain your payments.
2. Eliminate or pay down as much debt as you can. Your mortgage will most likely be your biggest monthly expense, but don’t be fooled, those smaller credit card, personal loan, and auto loan bills add up quickly. If an unexpected emergency was to occur and you don’t have the savings to handle it, you may find it difficult to juggle a mortgage payment along with the other debt that you’re carrying. A safer strategy would be to pay down as much debt as you can before you purchase, even at the expense of added time or a smaller down payment. (This will also make it easier for you to qualify for a loan because lenders are going to be judging your ability-to-repay (debt vs income ratio) when making their lending decision).
3. Look for a down-payment assistance program. Before purchasing your home, check your state of community’s website for information on any housing grants or assistance programs you may be eligible for. You may also consider reaching out to a local realtor or a HUD-Approved Counseling Agency to see if there are programs in your area that apply to your given situation.

If you have less than 20% down.

Perhaps you’ve heard the myth that in order to purchase a house you need at least a 20% down payment.

This is absolutely untrue, and there are several loan programs which allow you to purchase a house with a smaller down payment.

The trade-off to this is that if you have less than a 20% down payment, your lender is going to charge what’s called “Private Mortgage Insurance”. There are different types of mortgage insurance and each have their own specific guidelines.

Because your loan is considered risky, PMI is an insurance policy that’s rolled into your monthly payment (which you pay) that serves to protect the lender in case you default on your loan.

Minimum down payment requirements.

Conventional loan: 3% — 5%

The most common mortgage is called a conventional loan. These are loans which are backed and sponsored by Fannie Mae and Freddie Mac, which are government sponsored entities responsible for maintaining the mortgage market in the United States.

For conventional loans, you will have to pay PMI if you have less than a 20% down payment, but you can typically request the PMI to drop off once your loan-to-value ratio is at 80% (or it will automatically drop off at 78%). The amount of your PMI will vary based on your credit score, down-payment size, and loan amount.

There are some “Lender-Paid Mortgage Insurance” programs that you can secure to waive the PMI requirement, but most lenders will charge you a higher interest rate to compensate for the risk, so you’ll have to weigh out which direction is the most advantageous.

FHA loan: 3.5%

FHA loans are loans which are insured by the Federal Housing Administration. The main benefit of an FHA loan is that it provides a low down-payment option, has a lower credit qualification of 580+, and has lower income standards than a conventional loan.

For FHA loans, the PMI (in this case called MIP or Mortgage Insurance Premium), could either remain for the life of the loan, or it could fall off at year 11 depending on the size of your down payment.

VA loan: 0%

VA loans are loans which are guaranteed by the Department of Veteran’s Affairs. If you are a member of the military, reserves, or national guard, you are likely eligible for a VA loan.

While VA loans don’t charge PMI, there is a funding fee that comes along with them ranging between 2.15% and 3.3% of the loan amount depending on how many times the veteran has used their entitlement. The great thing about this fee is that it can be financed inside of the loan rather than paid directly out of pocket.

Do what you can afford.

The most important takeaway from this is that the optimal down payment really depends on where you are financially. If you have savings and are well established, a larger down payment is reasonable.

If you’re on a paycheck to paycheck schedule, it may make more sense to put a smaller down payment but keep money set aside for emergency savings and repairs which will inevitably come to surprise you.

If you plan it carefully, buying your first home is possible with both a large or small down payment, and is something to be excited about. I would just advise auditing your situation and coming to a conclusion that’s tailored to you.