Building the Foundation: A Deep Dive Into Mortgage Down Payment

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ByChristopher Boston
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Reviewed byTimothy Manni
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Updated: January 10, 2024

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Purchasing a home typically involves obtaining a mortgage, a type of loan specifically designed to finance real estate. Unlike other loans, mortgages are characterized by their long repayment terms and the collateral that secures them — the property itself. A crucial component of the mortgage process is the down payment, the upfront money you put towards the purchase. Knowing about your down payment options will help you make an informed decision that best suits your financial situation.

What Is a Down Payment?

A down payment is the initial cash payment you make when buying a home. Think of it as your first investment in your property. It's calculated as a percentage of the total home price and deducted from the overall home price to determine the mortgage loan amount you'll need to borrow. For example, let's say you want to purchase a home priced at $300,000. A down payment of 20% means putting down $60,000 upfront. You’ll need to secure a mortgage for the remaining balance, which would be $240,000 ($300,000 - $60,000).

Understanding the importance of the down payment is key to planning your home purchase because it affects both your mortgage terms and your ongoing financial commitment. Larger down payments can help reduce your monthly payments, possibly secure a lower interest rate and build equity in your home faster.

Homebuyers typically put in a down payment ranging between 3% and 20% of the home's purchase price. However, the "right" amount for you depends on various factors, including your personal finances and the mortgage program you select.

How Do Down Payments Work?

The down payment on your home doesn't just affect how much you owe on your house. It also has implications in several other areas crucial to the mortgage process. We’ll focus on three interconnected elements that your down payment impacts: the other aspects of your mortgage, the loan-to-value ratio and the need for private mortgage insurance (PMI).

Impact on Other Mortgage Aspects

Your down payment amount plays a crucial role in your overall mortgage plan. It shapes the terms and conditions of your loan, including interest rates, loan terms, monthly payments and even insurance requirements.

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Considering how much your down payment influences other aspects of your mortgage, it’s worth taking the time to think about how much you can comfortably afford to put down upfront when planning your home purchase.

Loan-to-Value Ratio

The Loan-to-Value (LTV) ratio is a key metric used by lenders to measure the ratio between the amount of your mortgage and the appraised value of the property. In essence, it shows the portion of the home's value that is financed by a loan versus how much you paid upfront.

You can calculate your Loan-to-Value ratio using this equation:

LTV = MA / APV, where:

  • MA is your mortgage amount
  • APV is your appraised property value

For instance, say you’re looking at a house with an appraised value of $200,000. A 20% down payment leaves you with a mortgage amount of $160,000. Dividing $160,000 by $200,000 gives you 80% — your LTV.

Lenders typically prefer a lower LTV ratio because it means your down payment covers a higher portion of the home's value. A lower LTV translates to less risk for the lender because they have a better chance of recovering their investment by selling the property if you default on your loan.

Private Mortgage Insurance (PMI)

When homebuyers make a down payment of less than 20% on a conventional loan, lenders typically require them to pay for private mortgage insurance (PMI). This protects the lender if the borrower fails to repay the loan. PMI is typically a percentage of the overall loan amount, which can significantly affect your monthly mortgage payments. Once your mortgage balance falls to 80% of the home's original appraised value, you can request to have the PMI removed.

Minimum Down Payment Requirements

The minimum down payment can vary significantly depending on the type of mortgage you qualify for. In fact, some loans require little to no down payment at all.

Here's a quick overview of common mortgage types and their minimum down payment requirements:

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Understanding the minimum down payment requirements for different mortgage types helps with budget planning. Exploring options to see which home loan aligns with your financial goals is crucial for homebuyers.

What Size Down Payment Should I Make?

Understanding the minimum down payment requirements for your mortgage is just the starting point. While it might seem advantageous to stick with the bare minimum, increasing your down payment can offer several benefits. However, the "right" amount varies depending on your personal financial situation and goals.

Pros and cons of making a larger down payment

Pros

  • Lower monthly payments: You'll borrow less, which results in lower monthly payments.
  • Lower interest rate: Lenders often offer better interest rates to those who make larger down payments.
  • No need for PMI with 20% down: If you put 20% or more down on a conventional loan, you can avoid paying private mortgage insurance (PMI).

Cons

  • More money upfront: You'll need to save more money, which may delay the homebuying process.
  • Less liquidity: Your money will be tied up in your house, leaving you with less cash on hand for other needs.
  • Opportunity cost: The money used for a down payment could have been invested or used for other financial goals.

Although a larger down payment can be beneficial, it may not always be the best option. In some situations, a smaller down payment might be a more viable strategy.

Pros and cons of making a smaller down payment

Pros

  • Allows you to buy a home sooner: You won't need to save as much money, speeding up the homebuying process.
  • More money for other expenses: You'll have more cash on hand for other immediate expenses.

Cons

  • Higher monthly payments: Your loan amount will be larger, resulting in higher monthly payments.
  • The need for PMI: If you put less than 20% down on a conventional loan, you'll probably need to pay for PMI, which will add to your monthly costs.
  • More interest paid over the life of the loan: A smaller down payment results in a larger loan, which increases the total amount of interest you'll pay.

Consider the short and long-term impacts of your down payment size — there's no one-size-fits-all answer. The best choice depends on your unique financial circumstances and homebuying goals.

Savings Strategies for Down Payments

Unless you qualify for a VA or USDA loan, it's likely you'll have to make a down payment, regardless of its size. If you already have some money set aside, that's a great start. If you don't, or if you're still working towards your goal, it's important to develop a plan to increase your savings. Here are some strategies to consider.

Budgeting Brilliance: Jane's Journey to Homeownership

Jane, a teacher with a passion for globetrotting and gourmet food, dreams of buying her own home. She takes a long hard look at her spending habits and decides to formulate a comprehensive budget. By focusing on essentials and reducing frivolous expenses, she's able to put aside extra funds each month toward her down payment.

Automated Abundance: John's Genius Savings Strategy

John, a software engineer with a knack for spending his leftover cash each month, decides to change his habit. He automates transfers from his checking account to a savings account dedicated solely to his down payment. This consistent approach to saving helps him resist the urge to spend his remaining balance every month.

Debt Demolition: Lisa's Liberation From Loans

Lisa, a recent graduate stepping into the world of work while juggling student loans, decides to make a smart financial move. She opts to concentrate on paying off her high-interest debts swiftly. This strategy increases her monthly saving capacity, allowing her to inch closer to her homeownership goal.

Income Increase: Mike's Freelancing Fortune

Mike, a graphic designer eyeing a down payment, resolves to fast-track his savings process. He starts taking freelance gigs in his free time, channeling the extra earnings straight into his down payment fund. His decision to sweat a little more now pays off as his savings start to swell.

Investment Ingenuity: Emma's Equity Expedition

Emma, a corporate professional with a keen interest in the stock market, decides to put her investing skills to work for her down payment. She strategically invests in diversified stocks and mutual funds, watching her money grow over time. Every dollar earned from her investments is added to her down payment fund. This strategy accelerates her saving process and brings her dream home within reach.

Saving for a down payment is a significant part of the home buying journey — with strategic planning and a little discipline, you can build up a substantial down payment over time.

Other Options to Secure Your Down Payment

Saving might be the most straightforward way to gather your down payment, but it's not the only one. You can also tap into other sources of funds, which can provide an effective boost to your down payment.

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Before you decide to take any alternative route, consider the potential benefits and drawbacks of each so you can ensure you’re making an informed decision.

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Each pathway to a down payment has its own unique set of advantages and considerations, so choose the one that best fits your circumstances.

A Closer Look at Down Payment Assistance Programs

Down payment assistance programs can significantly lighten the financial burden on homebuyers, especially those struggling to save enough for a down payment.

There are two broad categories of down payment assistance programs: state and local programs and those offered by non-profit organizations.

State and local programs vary greatly across the country, but their common goal is to support homebuyers within their jurisdiction. For instance, the Texas State Affordable Housing Corporation offers a grant that can be applied to a down payment or closing costs. Similarly, the Home in Five Advantage Program in Maricopa County, AZ, provides a grant of up to 6% of the loan amount to be used toward the down payment and closing costs. Eligible individuals may also qualify for an additional 1%.

On the other hand, non-profit organizations work at various levels, often nationwide, to provide down payment assistance. For example, the National Homebuyers Fund offers down payment assistance in the form of a non-repayable grant up to 5% of the mortgage loan amount. These programs may come with specific qualifications or restrictions, but they can be a valuable resource for those in need.

Down payment assistance programs can open doors to homeownership that might otherwise remain closed. Always research diligently and consider consulting a financial advisor or mortgage professional before making a decision.

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MONEYGEEK EXPERT TIP

When you find the home you want to buy, spend time plugging different down payment amounts into a mortgage calculator to determine what monthly payment works best for you. For most first-time buyers, paying for mortgage insurance is a reality, given how much money you need to save to reach a 20% threshold. So plug in your numbers to experiment with how a larger down payment reduces your monthly payment or how retaining some of your savings could offer an affordable monthly payment while still being able to fund repairs or furnishings following your loan closing. — Timothy Manni, Mortgage and Real Estate Consultant

Frequently Asked Questions

We've compiled and answered some frequently asked questions to help further your understanding of mortgage down payments.

While it’s most beneficial to pay a 20% down payment when purchasing a home, the National Association of Realtors found that the average first-time buyer put down 8% in 2021. Repeat homebuyers pay a higher down payment — 19%.

Down payments primarily come from savings. However, they can also be obtained through gifts from family, borrowed funds or down payment assistance programs.

A larger down payment can lead to lower monthly payments, potentially better mortgage rates and the elimination of the need for private mortgage insurance.

If you can't afford the minimum down payment, you can explore various down payment assistance programs or consider a loan type that requires a smaller down payment, like FHA or USDA loans.

Yes, with certain loan types like VA loans or USDA loans, it's possible to purchase a house without a down payment.

About Christopher Boston


Christopher Boston headshot

Christopher (Croix) Boston was the Head of Loans content at MoneyGeek, with over five years of experience researching higher education, mortgage and personal loans.

Boston has a bachelor's degree from the Seattle Pacific University. They pride themselves in using their skills and experience to create quality content that helps people save and spend efficiently.


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