By Holger Reinel | Updated on June 10, 2020
A 20% down payment isn’t realistic for most home buyers, especially for first-time home buyers.
When I decided to buy my first home, I saved diligently about 12% of my annual salary for about three years; my goal was to have a 10% down payment but settled for 5% after realizing that home prices were going up faster than I could save.
I was glad that I went with 5% because that allowed me to have funds left to cover the closing costs and moving costs; I also had to buy some furniture, and keep a small emergency fund to use in case there were unexpected costs after moving in. It worked out perfectly.
The size of the down payment depends on factors such as the home price, savings, credit score, and your specific financial situation.
You may often hear that the minimum down payment is some big number like 20%, but that’s not what borrowers are nowadays buying their homes with.
According to the National Association of Realtors, the median down payment from first-time home buyers was 6% in 2019. For repeat buyers that number is 16%.
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So, if 6% is the median down payment first-time home buyers put down to buy a house that means the other 94% is financed with a mortgage. The mortgage typically has a 30-year term and a fixed rate.
A down payment is the amount of cash that you put up-front which goes towards the purchase of the home. The down payment represents the starting equity you have in the home as the new legal owner; the remaining equity is owned by the lender.
In simple terms, your down payment, plus the mortgage you borrow equals the cost of the home. For example, if you’re buying a $600,000 property, and you’re putting a down payment of $30,000, you’ll need a mortgage for $570,000, (excluding closing costs).
Here are some of the benefits a down payment provides:
Lowering the mortgage payment
Serve as security for the lender as your partner in the transaction. The higher the down payment, the lower the risk assumed by lenders.
Reduce the interest paid over the term of the loan
When it comes to down payments, bigger is almost always better. Why? Because it lowers risk for the lender which may translate into being able to secure a lower interest rate.
Conversely, the lower the down payment, the higher the monthly mortgage payment is. Here is why:
Less money down means a larger mortgage loan
Lender may charge a higher interest rate because they are taking a higher risk.
You’ll have to pay mortgage insurance (PMI) if putting down less than 20%.
To illustrate, consider the following chart showing how the mortgage payment changes on a 30-year loan with a fixed rate of 3%.
Check out our mortgage calculator to find out your potential mortgage payment using the numbers that apply to you.
Here are the main factors lenders look at when evaluating to approve a mortgage loan:
Loan-to-value (mortgage amount vs. value of the home )
Debt-to-income ratio (total debt vs. your income)
Most borrowers buy their home with a 5% down payment; it’s not ideal, but it works.
Advantages of a 5% down payment:
The biggest advantage is getting your foot in the door. Make no mistake, a lower down payment means you’ll pay more in interest over time, but when interest rates are low, it makes sense to start with the lowest down payment required.
Also, you don’t have to save for years and years until you have a huge sum; besides, if you live in a city where home prices increase rapidly, it’s better to go in with the lowest down payment vs. getting priced out of the market for waiting too long.
Even if you have additional funds, it’s also important not to spend all your money on the down payment.
Once you move in, you may find the water bill is too high, or an appliance may brake; it’s good to keep a safety net or emergency fund to pay for unexpected expenses vs. stressing over how to pay for higher housing expenses.
Disadvantages of a 5% down payment:
The best way to determine whether your down payment is appropriate, be it 5%, 10% or 20%, is to ask yourself, “Can I afford the monthly mortgage payment”?
Remember that the lower the down payment, the higher the monthly mortgage payment is going to be.
Also, when you pay less than 20 percent, there will be mortgage insurance fees or PMI; not to mention the interest rate which may be higher with a 5% down payment.
Can I qualify for a mortgage with a low down payment?
Yes, you can. The down payment is an important element, but the driving factors are how much annual income you have and your credit score.
With an excellent credit score, and a 5% down payment you may get a mortgage with a lower interest rate than someone putting down 20% and a bad credit score. You have to shop around.
The opposite is also true; if you have a bad credit score, guess what? The lender will require a larger down payment.
It’s not just the down payment that determines how much house you can buy. Things like your income, credit score, amount of debt you’re carrying, and more, it all comes into the equation.
With $30,000 cash, assuming closing costs of $10,000, you’d be left with $20,000, which would get you a property for about $400,000 ($400,000 * 5% = $20,000).
A higher down payment allows you to finance a more expensive home without increasing the amount of your mortgage payment.
For instance, a $50,000 down payment on a $500,000 home gives you the same mortgage payment than buying a $470,000 home with a $20,000 down payment.
Not bad, right? The reality is, it can take decades to save for a 20% down payment; with home prices where they are, the process can be tricky, especially for first-time homebuyers or if you’re single.
These are the top advantages and disadvantages of a 20 percent down payment:
Advantage: You will avoid paying mortgage insurance (PMI)
Mortgage insurance protects the lender from payment default and it is a fee you must pay when putting a down payment that’s lower than 20%. That fee can easily add up to tens of thousands of dollars so it is a significant cost of homeownership.
Disadvantage: You’ll have less money left for closing and moving costs
While a large down payment reduces what you’ll pay in interest on the mortgage loan, it will create a short term financial crunch. As a new homeowner, you might find that owning a home has higher costs than originally planned.
For example, you might have to buy new furniture, or replace appliances. To do this, you want to remain financially flexible, to face those added costs; however, that won’t be an option if you spend all your money on a large down payment.
Advantage: You’ll have a lower mortgage payment & lower interest costs
Putting down a higher down payment will result in requiring a lower mortgage loan. This means paying less in interest costs, and the monthly mortgage payment could be hundreds of dollars lower, which makes homeownership more affordable even if your financial situation changes.
Disadvantage: It’ll take more time to save for a 20% down payment
In markets where home prices increase rapidly, it might not make sense to wait all the time required to sock away a 20% down payment.
Advantage: Better chance of getting a mortgage approval
Lenders will do an affordability assessment to confirm you can afford the mortgage. If your credit score isn’t great, or employment history is not long enough, a larger down payment will improve your chances of receiving an approval on the mortgage application.
Disadvantage: Better chance of getting a mortgage approval
Lenders will do an affordability assessment to confirm you can afford the mortgage. So, if your credit score isn’t great, or if the employment history is not long enough, a larger down payment will improve your chances of getting a mortgage approval.
The type of mortgage lenders provide can also determine the required down payment.
Conventional vs. High Ratio Mortgage Loans
Conventional mortgages require at least a 20 percent down payment and are not guaranteed by the government.
For example, if a house costs $400,000, the lender will extend a loan for 80 percent of the amount; so, $320,000 is financed with a mortgage, and the down payment is $80,000.
High ratio mortgages, however, have a down payment lower than 20%, they are insured against default and guaranteed by the government. Using the same above example of the house that costs $400,000, with a down payment of 5% you pay $20,000 in cash and the remaining $380,000 is mortgaged out.
To learn all about the different types of mortgages check out this article I wrote.
To buy an investment property you’ll need a down payment of at least 10 percent, and some lenders may require 20 percent. The reason why lenders ask for a higher down payment on investment properties is that they are deemed to have a higher inherent risk.
Since you won’t be living there, you likely rent out the property to tenants who will not maintain the property as well as you would.
Knowing the required down payment on a house is a key first step to buying your dream home. So, if you’re still wondering, how much is the required down payment to buy the house, here it is.
The recommended, and most common minimum down payment to purchase a house is 5 percent. Some programs like the FHA and VA allow an even lower down payment, but that doesn’t mean that’s what you should aim for.
Yes, you’ll have to pay for mortgage insurance (PMI), but in most cases, that’s better than continue paying rent while home prices keep increasing.
If you have the cash to put 20% down, go for it. You’ll save a lot on mortgage insurance and interest costs; however, if you don’t have 20%, that shouldn’t stop you. It is more important to make sure you can afford the mortgage payment than being too kin in coming up with a large down payment.
Buying a home is a large financial investment. To learn the home buyer’s process step-by-step check out our New Homebuyer Online course.
Taking this homebuyer course will enable you to navigate the home buying process with confidence.