SHARE

What Is A Down Payment?

There’s a lot of expenses to keep in mind when you’re thinking about buying a home. Between the price of the home, property taxes, your mortgage payments, insurance, and any additional commute expense, your brain may feel like a calculator! One of the largest expenses when purchasing a home is one that isn’t always front and center on your mind, and that is the down payment.

What is a down payment? Simply put, a down payment is a percentage of the home’s total purchase price. The lender will require you to put down a specific amount, which is equal to X % of the loan, or mortgage amount.

How Do Down Payments Work?

Down payments are a requirement for most types of loans. Down payments work by reducing the overall amount of your loan. For instance, if the home you’re looking to purchase is $300,000, and you put down a 10% down payment, you only need to finance $270,000.

Down payments also influence various terms of the loan, such as the interest rate, monthly payments, and mortgage insurance.

Interest Rates

The interest rate is essentially the fee a mortgage lender charges the borrower for using their money. A larger down payment reduces the lender's risk associated with lending any borrower money. Not only does a larger down payment mean the lender is lending less money, they also like to see the stake the borrower has in the property. If you were to put down a 20% down payment, you’ll likely have a better interest rate than if you put down 5%. Interest rates are throughout the entire duration of a loan. Any time you can reduce your interest rate, you have the opportunity to save a lot of money over the duration of your loan!

Monthly Payments

The less money you borrow, the less money you’ll have to pay back. As a result, your recurring monthly payment will be less. The below chart can help visualize this concept, on a high level. Note, this chart only highlights the principal balance of the loan and does not factor in taxes or insurance.

Price of Home

$300,000

$300,000

Down Payment

10%

3.5%

Loaned Amount

$270,000

$289,500

Years of Loan

30 year mortgage

30 year mortgage

Months of Loan

360 months

360 months

Monthly Payment 

$750

$804 

Mortgage Insurance

If you don’t put down a 20% down payment, many loans will require you to carry Private Mortgage Insurance, or PMI. Private mortgage insurance protects the lender, not the homebuyer. In the event you default on your loan, the private mortgage insurance company will pay your lender so the bank doesn’t lose money.

As the homeowner, you’ll still face financial consequences and can lose your home. This insurance is designed to reduce the banks risk of lending, which in return, allows more people to obtain a mortgage. However, PMI can be expensive, and will certainly add to your monthly payment.

Down Payment Amount

There is no silver bullet on how much down payment is needed for a house. Various mortgages require a specific amount of money down. For instance, a homebuyer who chooses to finance through an FHA mortgage can buy a house with as little as 3.5% down. On a $300,000 home, that's a $10,500 down payment. There are pros and cons to putting down a large, or small, down payment.

Benefits Of A Large Down Payment

A large down payment has undeniable benefits. First and foremost, the more money you put down on your home, the less money you have to finance. Financing comes with an interest fee, and when this interest fee is extrapolated over the lifetime of a loan, it certainly adds up. Higher down payments can reduce your interest rate as the lender has to lend less money - making the loan less risky in their eyes.

A larger down payment won’t only save you money on the interest side of the equation, you may be able to save money on insurance as well. Putting down 20% or more allows you to avoid paying Private Mortgage Insurance, or PMI. This can save you hundreds, or thousands, of dollars per month.

Additionally, your debt-to-income ratio, also known as DTI, will be lower. A debt to income ratio is important in much of the lending world, as this ratio looks at how much debt you have in relation to your overall income. Typically, if your DTI ratio is too high, you will not qualify for loans, whether that be a car loan, renovation loan, etc. If you put more money down on your home, you’re in less debt, which can help keep this ratio healthy for the other expenses in life.

Benefits Of A Small Down Payment

Putting a large down payment on your home can be challenging. Despite the benefits a large down payment has, there are also benefits to putting down a less amount.

Instead of paying a landlord, or living at home for a longer period of time, you may be able to purchase a home sooner rather than later if you put down less money. Saving up 3.5% of the purchase price on a home is a lot easier than saving up 20 percent.

If you chose to put down less of a down payment and kept some money in cash, you can use that cash for home repairs and improvements. You may be able to redo the kitchen, add a deck, or finish the basement. These improvements may mean a lot to you, and can also increase the value of your home.

Last, but certainly not least, you can keep money secured for an emergency fund. There is a great deal of responsibility when it comes to owning a home, and as a homeowner, you need to plan accordingly. Having a 3 month supply of money in an emergency fund is recommended by many financial experts. Therefore, you can continue to pay your bills in the event you weren’t able to work.

How To Buy A House With No Down Payment

Various loans have different down payment requirements. Let’s dive into some of the most common below.

Conventional Loans

The vast majority of conventional loans will require a down payment of 5 to 20 percent. If you happen to put down 20%, no mortgage insurance is required. Although possible, it is rare to find a lender who issues conventional loans with a down payment less than 5 percent. Typically, conventional loans have more strict credit and financial requirements for their borrowers.

FHA Loans

An FHA mortgage is a mortgage that is backed by the Federal Housing Administration. This is a common option for many first time homebuyers for two main reasons. The first reason being, the FHA does not have as strict of a credit score requirement. The second reason is, you can purchase a home with as little as 3.5% down. If your credit score is at least 580, all you need to put down is 3.5%. If your credit score is between 500 and 579, you’ll be required to do a 10% down payment.

USDA Loans

The United States Department of Agriculture provides homeowners in select areas the ability to finance a home through this program. There are certain requirements one must meet to qualify for a USDA home. However, those that do qualify enjoy the fact that a down payment is not a requirement. You can purchase a home with $0 down.

VA Loans

VA loans are made possible through the Department of Veteran Affairs. These loans are exclusively for veterans of the United States Armed Forces, or their qualified spouse. One of their main attraction pieces are, those who use a VA loan to purchase a home do not need to make a down payment. That’s right, you can keep all that cash in the bank and spend it as you please!

Put It All Together

Unquestionably, there are a lot of expenses to keep in mind whenever you are thinking about purchasing a home. Of which, the down payment is one of the most important. How much money you put down at closing will directly impact how much money you pay each month. Some borrowers wish to put down a greater down payment to reduce their monthly payment for the duration of the loan. Other borrowers elect to put down a smaller down payment, often adhering to the minimum amount. Therefore, they can keep more cash in the bank for whatever other expenses life throws at them! The choice is entirely up to you. There is a compelling case to do either option.

 

Ready to Make a Down Payment?

All material is presented for informational and educational purposes only and should not be construed as individual financial, investment, or legal advice or instruction. ZeroMortgage does not guarantee the quality, accuracy, completeness or timelines of the information in this publication. While efforts are made to verify the information provided, the information should not be assumed to be error free. Some information in the publication may have been provided by third parties and has not necessarily been verified by ZeroMortgage. ZeroMortgage, its affiliates, and subsidiaries do not assume any liability for the information contained herein, be it direct, indirect, consequential, special, or exemplary, or other damages whatsoever and howsoever caused, arising out of or in connection with the use of this publication or in reliance on the information, including any personal or pecuniary loss, whether the action is in contract, tort (including negligence) or other tortious action. ZeroMortgage does not provide tax advice. Please contact your tax adviser for any tax related questions.

This page last updated: March 21, 2022