Buying a house? Congratulations! Unless you’re independently wealthy, though, you’ll likely be taking out a loan to pay for your new home. Most mortgage lenders require a down payment before you can purchase a home. This will reduce the amount of the loan you take out. But how much is enough for a down payment? And what factors could influence it? We’ll help you make some sense of it all.
What Is a Down Payment?
A down payment represents your initial contribution toward owning your home. When you make a large purchase, you typically have to pay for at least some part of the cost upfront. Usually, a down payment is a percentage of the final purchase price. For instance, if you buy a house for $250,000, a 20% down payment would be $50,000.
After making this payment, your mortgage lender will supply the rest of the loan so you can purchase the property. Your remaining mortgage is then paid monthly to your mortgage servicer.
Not all mortgages will require a down payment, including some backed by the federal government (e.g., VA loans and USDA loans).
Each of these government loans has specific requirements that (and the home you wish to purchase) must be met to qualify.
Minimum Down Payments by Type of Loan
Mortgage lenders will typically establish a minimum down payment to purchase a home through a given loan program. This minimum down payment will vary by mortgage type, so it’s important to understand the requirements of each.
Conventional mortgages are not issued by the government, but will usually follow the guidelines of Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac are mortgage entities sponsored by the federal government.
With a conventional mortgage, your minimum down payment is determined by the mortgage lender or mortgage broker. Some require as little as 3% down. However, it’s customary to expect anywhere between 5% and 20% down payment or more depending on circumstances.
If you’re purchasing a house, you may want to consider whether you can afford a 5% down payment. In addition to the down payment, you may also need to pay additional costs, property taxes, or insurance.
FHA loans are backed by the Federal Housing Authority. An FHA loan will require as little as 3.5% down, although buyers may opt to put down more.
FHA loans can be helpful for home buyers who have low credit scores or lack the savings to contribute toward a large down payment.
However, the required down payment can be higher for those who have credit scores below 580. In addition, the property itself must meet specific health and safety standards before the loan can be approved.
If you’re struggling with your finances or have lackluster credit, FHA loans can be a good option, but these loans may be an inconvenient choice for those who have a better financial record.
VA loans are guaranteed by the U.S. Department of Veterans Affairs. These loans do not typically require a down payment, so if you or your spouse are a current member or veteran of the U.S. military, you may be able to take advantage of this program.
This benefit also extends to surviving spouses, so if your spouse served in the military and is now deceased, you may likewise qualify for a VA loan. Two things to keep in mind: one, there are funding fees associated with VA loans, although these may go down if you receive VA disability benefits; and two, veterans must have served for a specific length of time in order to qualify for the program.
USDA loans are backed by the United States Department of Agriculture. They do not require a down payment.
USDA loans are designed for rural and suburban homebuyers and are reserved for low-income families that might otherwise not meet the eligibility requirements of conventional loans.
Keep in mind that you must meet specific income requirements to be eligible, and the loan will only cover homes that are located in rural and select suburban settings as defined by the USDA.
How Does My Credit Score Affect My Down Payment?
As a general rule, the higher your credit score is, the better your chances will be to obtain a mortgage with a small down payment.
For example, an FHA loan will require a down payment of 3.5% if your credit score is above 580, but it jumps to 10% if your credit score is below that.
Other mortgage lenders may expect a larger down payment if your credit score doesn’t meet their requirements.
If you have average or poor credit, it won’t necessarily disqualify you from obtaining a loan, but you should be prepared to put down a figure much closer to the traditional 5-20% to secure a loan with an affordable interest rate.
Why Choose a Small Down Payment?
Some home buyers may wish to seek out a mortgage broker that can offer low minimum down payments. While this will invariably raise your monthly mortgage premiums, there are many reasons why you might opt to put down a low down payment. These include:
You have less money to put down
Everyone deserves a roof of their heads, but not everyone is in the best financial position to purchase their dream home just yet. This is especially true after the 2020 pandemic, in which many middle-class families were hit hard by shutdowns and quarantines.
A low down payment can put homeownership within reach, even if your financial situation has been less than optimal.
You need funds to renovate
Sometimes, your dream home needs a little work. Sometimes, it needs a lot of work! When you buy a fixer-upper, you may have to factor in the cost of renovation and repair.
What do you plan on doing? New flooring? Updated kitchen cabinets? Maybe you want to build an addition for an extra bedroom. Whatever your plans may be, you’ll want to keep some money in your bank account to cover the costs.
Putting less money toward your down payment can ensure that you have enough money remaining to complete your desired upgrades and repairs.
You have other financial goals
Starting a family? Paying for college? When you’re making a home purchase, you should account for all of your long-term financial goals. A small down payment can ensure that you have money in your savings account to cover other important things.
Buy a home sooner
If you’re currently renting, it may be frustrating to continue spending money on a property that you will never own.
At the same time, high down payments may put homeownership just out of reach. If you can find a mortgage lender that requires a small down payment, homeownership moves from your bucket list to your immediate future.
Instead of waiting until you save enough for a 20% down payment, you can achieve homeownership sooner and avoid sinking money into a rental property.
Build equity sooner
Buying a home has a secondary benefit: It allows you to start building equity quickly. What is home equity? Home equity is measured by the difference between the amount of money you’ve paid on your mortgage and the amount that your home is worth.
Granted, you can build equity quickly by ponying up a large down payment, but a small onewill let you move into your home and start building equity.
Home equity can be accessed through refinancing or a home equity line of credit (HELOC), where it can be used to finance home improvements, educational costs, debt consolidation and more.
Why Choose a Large Down Payment?
Historically, home buyers have expected to put down 20% for a down payment. While this might mean you have to take more time to save enough money, a larger down payment has distinct advantages, including:
Lower monthly premiums
The more money you pay upfront, the lower your monthly mortgage premiums will be.
Dipping into your savings may sound painful, but it will mean that your mortgage will take a smaller bite out of your monthly budget. Since most mortgages last 30 years, these savings can really add up over time, so it’s often worth it to put more money down at the very beginning.
A better mortgage interest rate
Many mortgage brokers associate a lower down payment with increased risk of default, so they may jack up your interest rates as a result.
Conversely, when you put down a large down payment, your mortgage lender may offer you a better interest rate. A lower interest rate will save you money, since your monthly payments will be applied to the principal balance, rather than the interest fees.
More equity in your home
When you invest in your home through a large down payment, this allows you to have more home equity within reach from the moment you move in.
Bottom Line: How Much Down Payment Do I Need for My Home Purchase?
As a general rule, you’re best off when you make as large of a down payment as you can afford. A down payment of 20% is usually a good goal.
If this target doesn’t match your current financial goals, you can likely find a mortgage lender who will allow a lower down payment, so long as you’re comfortable with higher monthly premiums and a potentially higher interest rate.
Many home buyers take the opposite approach and put down as little as possible. This plays to the saying that “cash is king” and can be better spent or invested in better places than the sunk equity of your home.
When you speak with your lender, you should expect to discuss your current financial status and future plans, including your:
- current savings
- current credit score
- financial goals
- monthly income
This will allow your mortgage lender or broker to assess your needs and guide you in making a decision that’s right for you and your family. At the end of the day, there are many paths to homeownership and there are many resources to help you get there.
Got Questions? Ask Agave Home Loans
Sometimes, the more you learn, the more questions you have! Agave Home Loans is here for you. We’d love to have a conversation with you and answer any questions you may have. Contact us today, and make sure to stay in the loop with the Agave Home Loans newsletter, too.
This blog is actually more about “What is a down payment?” than “How much.” I’d advise a different headline by merging the two:
“Down Payments: What Are They and How Much Do You Need?”
Marshall spent seven years in hospitality and the restaurant industry prior to beginning a career in real estate and lending. After obtaining a finance degree with an emphasis in investments from Northern Arizona University, he began working at Quicken Loans. He spent seven years there as a banker and then Senior Director prior to co-founding Agave Home Loans. (NMLS ID: #1107208)