Down Payment: What Is It And How Much Do You Need?

You’ve decided to buy a house. Congratulations!

Now is the time to familiarize yourself with the home buying process, but one of the first things you need to do is save for a down payment.

Saving for a down payment can be a challenging hurdle to clear on the path toward homeownership – but it’s not impossible. Your down payment amount will impact your ability to get a mortgage. And depending on its size, your down payment can help you to be seen as a competitive buyer in hot real estate markets.

Let’s see how down payments work and how much you’ll need.

What Is A Down Payment?

A down payment is a percentage of a home’s purchase price a buyer pays upfront at closing. Your total loan amount is the difference between a home’s sale price and your down payment.

Down payment funds can come from savings, investments, gift money from eligible donors, home equity or assistance and grant programs.

Down payments are usually required to show mortgage lenders and sellers that you’re serious about becoming a homeowner and that you can repay the money they loaned you. It allows you to have some investment in the property, and most loan programs do not allow a borrower to take 100% of the home’s value, anyway.

Why Is A Bigger Down Payment Better?

Cash is a good motivator, especially in a highly competitive real estate market. Sellers may choose buyers with a larger down payment because of the higher chance that their financing will be approved.

A lender may also see a buyer who puts down less money as riskier than one who can put down a larger amount because they are borrowing more money and have less investment in the property. The buyer with the smaller down payment may end up with a higher interest rate and be required to pay mortgage insurance.

Not being able to make a larger down payment shouldn’t stop you from buying a home. If you make a low down payment, you may pay private mortgage insurance (PMI), or your lender may charge a higher interest rate, but you’ll finally have a place to call your own and the opportunity to build wealth over time through your home.

You’ll build home equity as you make your monthly mortgage payments and can refinance your mortgage loan later to remove PMI or lock in a lower interest rate and more favorable loan terms.

Earnest Money Vs. Down Payment: What’s The Difference?

Your down payment is money you pay upfront that makes up the difference between the price of the home and the amount you borrow. Earnest money, also known as a good faith deposit, acts as a retainer on a property and represents a buyer’s serious intent to buy a home.

The seller doesn’t keep the deposit. The money sits in an escrow account that neither the buyer nor seller can touch until the transaction is complete or someone voids the contract.

When a buyer completes the transaction, their earnest money deposit can go toward their down payment or closing costs.

How Do Down Payments Work?

A down payment reduces the amount you borrow from a mortgage lender.

Let’s say you’re interested in a home listed for $400,000. If you’re borrowing money to pay for the home, mortgage lenders will require at least a 3% down payment – or $12,000 – for most conventional mortgages.

If you don’t qualify for a loan to fully cover the purchase of a house, you can make a bigger down payment to cover the difference.

Earnest money – which is 1% – 3% of a home’s purchase price – is held in an escrow account until the deal is complete. Your escrow deposit isn’t an added expense in the home buying process. It can be rolled into your down payment at closing. Earnest money can lower the amount you need to bring to closing for your down payment.

On a $400,000 loan, the earnest money deposit would be between $4,000 and $12,000. If you make a $12,000 escrow deposit, no additional funds will be required to fulfill the minimum 3% down payment amount.

How Much Of A Down Payment On A House Will You Need?

How much down payment is required depends on the type of mortgage you’re using, the type of property you’re buying and your financial and credit situation. However, the down payment you should make on a house will also depend on your unique circumstances.

Here are some other important factors to consider to help guide your thinking:

●      When do you want to buy? You can buy sooner with a smaller down payment.

●      How much do you want to borrow? You can take out a smaller mortgage loan with a larger down payment.

●      How is your financial standing? Lots of debt and a marginal credit score could mean making a larger down payment.

●      What type of mortgage loan do you want? Each loan has its own down payment requirements.

Down Payment Required By Type Of Loan

Minimum down payment requirements will depend on the mortgage loan you select. Below are common mortgage loan types and their down payment requirements.

●      Conventional loans: The down payment requirement for a conventional mortgage depends on whether it is a conforming or nonconforming loan. Most conventional lenders require a 3% down payment for first-time buyers and 5% for repeat home buyers. A 20% down payment is required only if you wish to avoid paying PMI.

●      FHA loans: The minimum Federal Housing Administration (FHA) down payment is typically 3.5%, but you’ll pay a mortgage insurance premium (MIP). Your FHA loan mortgage insurance includes an upfront premium and an annual premium based on your total loan amount.

●      Jumbo loans: The most common nonconforming loans are jumbo loans because they exceed the conforming loan limits set by Fannie Mae and Freddie Mac. Because jumbo loans are unregulated, lenders can set their own down payment requirements, typically ranging from 10% – 20% or higher. Our sister company Rocket Mortgage^® offers the Jumbo Smart loan with borrowing limits of up to $3 million and down payments starting at 10.01%.

●      VA loans: The Department of Veterans Affairs (VA) offers VA loans as a benefit to military service borrowers and eligible surviving spouses. VA loans have no down payment requirements for eligible buyers unless the purchase price exceeds the home’s appraised value.

●      USDA loans: The U.S. Department of Agriculture offers USDA loans to low- and middle-income wage earners buying a home in a USDA-designated area. USDA loans have no minimum down payment requirement, and home buyers can choose to roll their down payment and closing costs into their loans. Rocket Mortgage does not currently offer USDA loans.

Each loan program has a minimum down payment requirement (or no requirement), but it’s best to save as much as possible to buy a house. The more money you invest in a house, the less you need to borrow. The lower your principal balance, the lower your monthly mortgage payment and the less interest you pay over the life of the loan, keeping your total cost to buy a home lower.

Down Payment By Required Credit Score

Down Payment By Property Type

Lenders view loan applications differently depending on the home buyer’s reason for purchase. Because of this, the minimum down payment can vary by property type.

●      Primary residence: Lenders see a borrower’s primary residence as a safe investment and require the lowest down payment amount.

●      Vacation home: Lenders typically consider vacation or second homes a riskier investment than a primary residence. To mitigate this risk, lenders typically require larger down payments and higher credit scores, and charge higher interest rates for these types of loans.

●      Investment properties: An investment loan is also considered a riskier investment than a primary residence. Mortgage lenders need assurance that you can continue to make your monthly mortgage payments even when the property isn’t generating a profit. And they will typically require a larger down payment and a higher credit score.

Down Payment By Property Type At A Glance

Down Payment Assistance Programs

Down payment assistance programs help home buyers afford the down payment on their dream home. The Department of Housing and Urban Development (HUD) offers several state and local programs.

The programs typically offer low-interest loans or grants to help cover home buying costs. Your eligibility for assistance depends on the program and other factors, such as income and credit history. Grants are typically based on your location and financial need.

In most cases, these programs are targeted at first-time home buyers, typically defined as people who haven't owned a house or residence in at least 3 years. There are also down payment assistance programs targeted at low- to middle-income home buyers.

It’s important to point out that not all lenders will accept all down payment assistance programs. It is highly recommended that you speak to a loan expert to determine what down payment assistance programs they will accept.

Down Payment FAQs

Let’s answer some of the most common questions home buyers have about down payments.

Who gets the down payment on a house?

The down payment is typically held in an escrow account until the real estate transaction is complete. Once the transaction is finalized, the buyer can use the escrow deposit toward their down payment. At closing, the down payment is technically released to the seller.

What’s the relationship between down payment and home equity?

Your down payment adds to the amount of equity you have in the home. For example, a 5% down payment on a $400,000 home translates to $20,000 equity in the home. Home equity decreases the debt and allows homeowners to access the cash stored in their homes to pursue other financial goals.

Do I need any other cash to buy a house?

In addition to a down payment, home buyers will need cash for closing costs, which is generally between 3% and 6% of the purchase price. Home buyers will get a Loan Estimate after getting initial lender approval and a Closing Disclosure that outlines the total costs of the mortgage at least 3 days before closing.

Why do lenders like larger down payments?

Lenders consider loans accompanied by larger down payments less risky because the buyer has a greater financial stake in the property. And by putting down more money, buyers can typically benefit from a lower interest rate.

What is the average down payment on a house?

The average down payment for home buyers is 8%, according to the National Association of REALTORS. However, rising home prices have made larger down payments difficult for many home buyers.

Do I need to make a 20% down payment on a house?

Buyers don’t need to make a 20% down payment unless their credit history warrants a larger down payment. But if you can make a 20% down payment, you may avoid paying PMI on a conventional home loan.

The Bottom Line

The home buying process has a lot of moving parts, and your down payment is one of the most essential.

While a larger down payment may offer better loan terms, you may be able to use a loan program that can help you become a homeowner with a lower down payment.

If you’re ready to start your home buying journey, start the mortgage application process today and see what you may qualify for.