When you begin shopping for a house or investment property, one of the first questions to sort out is how much down payment you want to make. For reference, the average down payment on a house hovered around 12%, with a lower average (6%) for first-time home buyers. Still, a higher down payment can help you begin building equity faster.
What is a down payment on a house?
A down payment on a house is a lump sum that you pay that equals a percentage of the total cost of the house when the rest of the payment will be in the form of a mortgage. You pay your down payment at the same time that you initiate your mortgage loan. It is required for at least two reasons, both related to how risky giving you a mortgage loan may be. First, it increases your investment, and second, because it means the lender is more likely to recoup their losses if they repossess your home for lack of payments.
Say you buy a house for $100,000, with a lender who ideally wants a 20% down payment of $20,000 (this is a hypothetical situation, not the actual required down payment). Your $20,000 is now tied up in that house purchase, for better or for worse, so you have a good reason to keep paying on the house and keeping it in your name. If you do stop paying, however, the lender is only out of $80,000, so they can sell the house for less than your purchase price and still get their money back.
Minimum down payment requirements by mortgage type
In a conventional loan, your minimum down payment can depend on a few factors. If it is backed by a semi-governmental lender and fits into particular programs, you may be required to pay only 3% down. For other conventional loans, your lender can require different rates, though common required down payments are in the 5-15% range.
The Federal Housing Administration offers loans with 3.5% down payments to qualified borrowers, and the Veterans Administration and United States Department of Agriculture each have loans that actually don’t require a down payment at all. These loans all have additional stipulations, from location and credit requirements to being a veteran or active member of the United States Armed Forces.
Getting the lowest possible down payment often requires meeting credit score requirements, paying additional fees at closing, or paying for private mortgage insurance (PMI). If you can save a little longer and pay a larger down payment at the start of your loan, it sometimes saves you money in the long run.
Benefits of larger down payments
Your choice to make a larger down payment improves your mortgage loan by making it smaller, but it also has some other valuable impacts on your home buying experience.
- Better interest rate — Lenders see you as a lower risk when your down payment is larger, which can qualify you for their lowest rates.
- Lower fees — Some loans will allow a low down payment only with PMI, which adds fees. Higher down payments create the opportunity for removing that or other fees.
- Higher equity from the start — Your own investment is more secure when you have a large down payment, because you have more equity. People who have very low down payments are more likely to “go underwater,” or owe more than the value of the house if values go down. High down payments give you a substantial buffer to keep that from happening.
- Lower monthly payment — Because your overall mortgage principal is lower with a large down payment, you have a lower ongoing obligation to pay, which can be helpful for your cash flow.
How does your down payment affect loan-to-value ratio?
An important figure in home buying is your loan-to-value ratio, or LTV. When your loan’s principal is 80% or less of the total value or purchase price of your home, you are usually no longer required to pay private mortgage insurance, a substantial savings. So putting a big down payment can help you get closer to a good LTV faster.
There are times when home values drop, at least a little, and having a good LTV makes sure you aren’t stuck with a house valued less than the price you’re going to pay for it over the life of the loan.
What is the average down payment on a house?
The average down payment was 12% of the home purchase, according to National Association of Realtors 2020 figures. In 2021, this rate should hold steady, though if the Biden administration introduces tax credits for first-time home buyers, the average down payment for first-time home buyers (6% in 2020) could go up to take full advantage of the credit available. Otherwise, if mortgage rates stay fairly low, down payment size might go down, given the lower incentive to pay large down payments upfront when you can get a very low interest rate even without one. Low mortgage rates also motivate people to refinance their homes for a better rate after they’ve paid on the loan for a while.
We welcome your feedback on this article. Contact us at email@example.com with comments or questions.