Choosing the right down payment amount has a big role to play in buying a house. Especially for first-time homebuyers, understanding the value of a down payment — and how it saves you money in the long run — may make it easier for you to save up.
Making a larger down payment means that you will have smaller mortgage payments each month. These monthly savings add up over the life the loan but require having more money available at the time of purchase.
What is a down payment?
A down payment is a lump sum of money that goes directly to the person selling the house. Your mortgage lender will pay the seller the rest of the purchase price.
The amount of money you borrow from the lender is your mortgage. You will make monthly mortgage payments to the lender for the length of the loan, usually 15 or 30 years.
Why are down payments required?
The down payment goes directly to the seller and immediately establishes your equity, which is the difference between the value of the home and how much you owe for any mortgages on the property.
This provides protections to the lender by reducing the risk that your mortgage will ever be more than the value of the property.
Why does it matter how much I put down?
- The down payment helps lenders know what kind of mortgage loan and interest rate you qualify for. The larger the down payment, the less risky the loan is for the lender, therefore they are more willing to give better loan terms.
- Your down payment decides the size of your mortgage (and monthly payments) over the life of the loan. The larger the down payment, the smaller your monthly mortgage payment will be.
Coming up with a down payment
Most people need to save to come up with a down payment, but it’s worth making the effort. Here are some ways to save:
- Save money from each paycheck: Take some of your income and put it into a down payment savings account.
- Sell things: Look at what you own and sell anything that you don’t use.
- Gifts: If your family and friends gift you down payment money, check with your loan officer to make sure it meets the rules.
Note: You may want to borrow money for your down payment by taking out a property loan, but that extra debt will make you a less appealing buyer in the seller’s mind.
Use a down payment calculator
A down payment calculator will help you decide how much to put down by considering the location and the price range of the house.
The calculator will use your financial information to identify different mortgage types available. The results will estimate for you:
- The minimum down payment for each type of loan
- How the down payment will impact your monthly payments
- Closing costs on the house you are considering
Making a down payment
If you can afford it, there are benefits to making a down payment of 20% or more of the purchase price of the house.
- Private Mortgage Insurance
Private mortgage insurance (PMI) is required for down payments of less than 20%. The smaller your down payment, the higher your PMI will be.
PMI, which is added to the monthly mortgage payment for the life of the loan, will impact the amount you can afford to borrow.
Many homeowners chose to pay PMI rather than wait until they can make a larger down payment.
- Closing Fees or higher interest rates
If your down payment is under 20%, the lender may charge closing fees. And closing fees are usually higher the smaller the down payment is. Sometimes, lenders charge a higher interest rate instead of closing fees.
Remember, only a small percentage of homebuyers can make a large down payment. And there are many options for homebuyers who can make small down payments.
Check with your county or city housing authority for more information on current programs that you may qualify for.