The SCOOP! Blog by ChangeMyRate.com®

What is a down payment when you buy a house? A home down payment is simply the part of a home’s purchase price that you pay up front and does not come from a mortgage lender via a loan.

Suppose you want to buy a house for $100,000. The seller gets $100,000.

• If you bring $3,000 towards the purchase price, or put 3 percent down, the mortgage lender provides $97,000. Your down payment is three percent ($3,000 / $100,000) and the lender provides a 97 percent loan ($97,000 / $100,000).
• If you pay $20,000 and the lender finances $80,000, your down payment is 20 percent and your loan is 80 percent.

Mortgage lenders often refer to the percentage of the purchase price that they finance as a loan-to-value, or LTV.

• When you put $3,000 down on a $100,000 house, your LTV is 97 percent.
• When you put 20 percent down on a $100,000 house, your LTV is 80 percent.

The term LTV is important because that is how lenders describe the maximum loan they will make.

Sources for your mortgage down payment

There are many ways to come up with a down payment to buy a home. For repeat buyers who have positive equity, it’s often the proceeds from the sale of their previous home. Other sources include:

• Savings
• Selling assets like cars or collectables
• Borrowing against a 401(k) retirement plan
• Down payment assistance (DPA) programs from employers, nonprofit organizations and government agencies
• Gifts from family members and friends

Some down payment sources, however, are not allowed by lenders. These include loans or gifts from anyone who would benefit from the transaction, such as the home seller, real estate agent or lender.

Why mortgage lenders require a down payment

Very few mortgage programs allow 100 percent –or zero down– financing. The reason for requiring a down payment on a home is that down payments, or money used to pay down the purchase price, reduce the risk to the lender in several ways:

• Homeowners with their own money invested are less likely to default (stop paying) on their mortgages.
• If the lender has to foreclose and sell the property, it’s not on the hook for the entire purchase price, which can limit its potential losses if the home is sold for less than the remaining mortgage balance.
• Saving a down payment requires discipline and budgeting. This can set up borrowers for successful homeownership.

There are two very specialized government-backed loans that require no down payment. They are VA loans for servicemembers and veterans and USDA loans for eligible buyers in rural areas.

Why down payments are good for buyers

If you have never owned a home, saving for a down payment provides good practice for homeownership. Suppose you currently rent a house for $800 per month. And that the payment for the home you want to buy would be $1,200 per month. You can “practice” for homeownership by putting the $400 difference into savings. This accomplishes three things:

• Your down payment savings grows.
• You get used to having less spending money.
• You may avoid an expensive mistake if you realize that you can’t handle the larger payment

Many financial experts agree that having a down payment is a good sign that you’re ready for homeownership. If you can make the necessary sacrifices to amass a down payment, then you’ll likely be able to manage expenses that come with owning a house, including monthly mortgage payments, maintenance costs and property taxes.

What is the minimum down payment on a house?

Most first-time buyers want to know the minimum down payment on a house. That depends on the mortgage program, the type of property you buy, and the price of the home.

Assuming a 4% interest rate. Source: Bankrate.com, Radian mortgage insurance calculator

For many first-time buyers, the down payment is their biggest obstacle to homeownership. That is why they often turn to loans with smaller minimum down payments. Most of these loans, though, require borrowers to purchase some form of private mortgage insurance, or PMI. Typically, lenders will require PMI if you put down less than 20 percent.

However, mortgage insurance is not a bad thing if it gets you into a home and starts you on the road to building equity. Consider this: if you save $250 a month, it will take you more than 12 years to accumulate the $40,000 needed for a 20 percent down payment on a $200,000 house.

Minimum down payments range from zero to 20 percent for most types of mortgages.

Types of down payment: FHA, VA and USDA

Some of the mortgage programs requiring the smallest down payments are government-backed loans: FHA, VA and USDA.

• FHA loans require 3.5 percent down for applicants with credit scores of 580 or higher.
• FHA borrowers with lower credit scores (500 to 579) must put at least 10 percent down.
• Eligible VA loan borrowers can get mortgages with zero down (100 percent LTV).
• Eligible USDA borrowers can also borrow 100 percent of the property value.

Government-backed loans require borrowers to pay for some form of mortgage insurance. With FHA and USDA loans, it’s called MIP, or Mortgage Insurance Premium. For VA loans, it’s called a Funding Fee. The insurance covers potential losses suffered by mortgage lenders when borrowers default. Because insurance protects lenders from losses, they are willing to allow these low down payments.

Down payment for conventional (non-government) mortgages

You might be surprised to find that some private mortgage programs also have low down payment requirements. Most conventional loans have guidelines set by either Freddie Mac or Fannie Mae. Because these loans must conform to this set of guidelines, they are called “conforming” loans. To offset the risk of lending with smaller down payments, conventional lenders require borrowers to purchase private mortgage insurance, or PMI, when they put less than 20 percent down on a home.

• With mortgage insurance, you can borrow up to 97 percent of the home’s purchase price under these programs.
• Some property types like duplexes, condominiums or manufactured houses require at least 5 percent
• In general, the larger your down payment, the better your interest rate, and the less you’ll pay for mortgage insurance.

There is a trade-off between your down payment and credit rating. Larger down payments can offset (to some extent) a lower credit score. Higher credit scores can offset (to some extent) a lower down payment. It’s a balancing act.

Bigger down payment equals more house

Larger down payments don’t just make it easier for you to get approved for your mortgage. They allow you to buy more house for the same monthly payment. Here’s an example of how a larger down payment gets you more house for the same monthly payment:

Finley and Kerry each can afford to spend about $925 a month on a house payment, excluding taxes and homeowners insurance. Kerry has $15,000 more saved for a down payment and can afford to spend about $32,000 more for a house.

Home down payment: when bigger isn’t better

While making a larger down payment offers many benefits, it’s not always the right decision.

• Don’t deplete your emergency savings to increase your down payment. You’re leaving yourself vulnerable to financial emergencies.
• It’s not wise to put savings toward a larger down payment if you’re carrying high-interest debt like credit cards. You’ll make yourself safer and pay less interest by reducing debt before saving a down payment.
• Putting off buying a home for many years to save a large down payment can be a mistake. While you’re saving your down payment, the price of that house is probably going up. While home price appreciation is not guaranteed, real estate in the U.S. has historically increased by about 4 percent per year, according to Black Knight). In 12 years, a house costing $200,000 today may be priced at over $300,000.

The size of your mortgage down payment is obviously a very personal decision. Tools like mortgage affordability calculators can help you determine the right amount for you, and so can a trusted mortgage professional. But ultimately the decision comes down to your desire, your discipline and your resources.

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