A down payment on a house is the up-front payment a home buyer must provide in order to secure the amount that is borrowed. Most mortgage lenders require that consumers make cash down payments of 3% to 20% to be approved for a home loan. These requirements and costs will differ depending on your credit score, mortgage type, and home value. To help you understand the costs of buying a home, we've explained how mortgage down payments work.
- Explaining Mortgage Down Payments
- How a Down Payment Works
- Down Payments For First Time Home Buyers
- Mortgages with Low Down Payments
Explaining Mortgage Down Payments
For mortgages provided by banks and credit unions, known as "conventional loans," government guidelines require a down payment of at least 3% of a home's purchase cost. For example, for a $250,000 home, you'd be required to pay at least $7,500 in upfront cash. Homes that cost more than the legal conforming limit on mortgages — a figure usually around $424,100 — are known as "jumbo loans" and come with stricter qualifying requirements, including higher down payments. Government backed FHA loans require down payments of 3.5%, while VA loans for veterans have no down payment requirements.
|Mortgage Type||Backed by...||Minimum Down Payment||Best For...|
|Conventional||Bank or credit union||3%|
For both FHA and conventional loans, bigger down payments will allow for lower monthly costs. The key difference between the two types of mortgages revolves around the issue of mortgage insurance. FHA loans are guaranteed by the government, so that the lender is paid back with federal funds if the borrower defaults. Conventional mortgages are not backed by the government, and they require you to pay for private insurance to cover the cost of default. However, conventional lenders waive insurance fees if down payments exceed 20%, and allow you to stop paying mortgage insurance once 20% of your mortgage balance is paid down. The FHA requires that you pay mortgage insurance for the life of the loan.
How a Down Payment Works
The size of your mortgage down payment impacts your loan amount, interest payments and mortgage insurance costs. A larger down payment means that you'll have to take a bigger chunk out of your savings, but will allow you to take out a smaller loan amount — leading to lower overall costs. A smaller down payment will be more affordable at the time of your purchase, but will lead to a much more costly monthly mortgage payments.
To illustrate the differences you can expect with a range of down payments, we calculated monthly principal, interest and insurance costs for a 30-year fixed rate conventional mortgage at a 4.5% APR.
Effects of Down Payment on Monthly Costs for a $250,000 Home
|Down Payment (%)||3.5 %||10%||20%||25%|
|Down Payment ($)||$8750||$25,000||$50,000||$62,500|
|Monthly Principal and Interest||$1,222||$1,140||$1,013||$950|
|Monthly PMI Premium||$231||$101||$0||$0|
|Total PMI Costs||$24,255||$7,373||$0||$0|
|Total Cost of Loan||$464,311||$417,788||$364,813||$342,013|
If you have a fixed monthly mortgage budget, a bigger down payment allows you to finance a more expensive home without increasing your monthly cost. For example, if your monthly budget is $925, a $5,000 down payment (or 3%) on a 30 year mortgage could get you a house that costs about $170,000 — while a $20,000 down payment (or 10%) will allow you to buy a house that costs $200,000.
A bigger down payment on a conventional loan will also speed up the process of reaching 80% on your loan-to-value (LTV) ratio, which is the percentage of how much you still owe on your mortgage. You can stop paying mortgage insurance once the cash you've paid towards your home, including the down payment, reaches 20% of your home's value, or 80% LTV — which reduces your monthly payments. However, you should keep in mind that FHA loans require you to pay insurance for the life of the loan.
If you want to make a 20% down payment to avoid being hit with mortgage insurance fees, you can estimate how much home you can afford by multiplying your savings by five. For example, if you had $34,000 in your savings — the average savings account balance in 2013 — you could afford to finance a $170,000 home without purchasing mortgage insurance. With this budget, any mortgage larger than $120,000 will lead to more expensive monthly payments from higher interest rates and insurance premiums. As such, it is important that you factor these monthly costs into your budget when determining the amount of mortgage debt you can afford.
Down Payments for First Time Home Buyers
Many first time home buyers struggle to get approved for mortgages because they can't meet the typical 20% down payment minimums on the size of home they want. Others find that poor credit results in much higher up-front costs. If either of these describes your situation, you may be able to reduce your down payment through a government loan. Both the Federal Housing Administration (FHA) and the Veterans Administration (VA) run mortgage programs for eligible Americans.
First-time home buyers with little credit history or a poor credit profile might consider applying for an FHA mortgage rather than a conventional loan. Consumers with low credit scores can be approved for these government-backed loans, although those with credit scores below 580 must provide a down payment of at least 10%. Borrowers with poor credit also tend to receive higher interest rates, which can drastically increase your monthly mortgage payment. However, FHA loans are also a good option if your credit score is above 580 but you want to make a smaller down payment than allowed by a conventional lender.
As with other forms of debt financing, you're most likely to be approved for an affordable loan if you've built a strong credit profile and have healthy savings. A good first step is to apply for and pay off smaller credit products like credit cards that can help you raise your FICO credit score. Another method that many states have begun offering are first-time home buyer savings accounts.
Mortgages With Low Down Payments
It's possible to pay a low down payment on a conventional loan if you have excellent credit, but most banks require a down payment of 5% or more for the average borrower. Government-backed FHA mortgages, which have a 3.5% minimum down payment, can be a more affordable option for those seeking a smaller up-front cost — though, as mentioned above, all FHA borrowers must pay monthly insurance costs for the life of the loan.
Similarly, conventional loan borrowers who make a down payment of less than 20% must also pay monthly private mortgage insurance (PMI) until they have paid for 20% of their home. The added MIP or PMI fee can be a pricy long term expense and may negate the financial benefit of making a low down payment. Given the large expense of buying a home, it's most advisable to save enough money to make a 20% down payment and avoid paying for insurance, especially if you expect your budget to be tight in the coming years.
For veterans and their eligible spouses, VA loans are the most affordable way to finance a home purchase. These mortgages require neither a down payment nor any private mortgage insurance, reducing both your initial costs and monthly payments.