Down payments are one of the most talked-about and important parts of buying a home. They are also very complex and often misunderstood. To help make sense of it all, we are going to breakdown down payments and answer five of the biggest questions around them: why does your down payment matter, how much do you have to put down, what other costs do you need to save for and consider, how can you afford a down payment, and, finally, how much should you even put down?
Before we get started, let's quickly define what a down payment even is. A down payment on a house is cold hard cash that you are using to partially pay for a house. Typically, in addition to the down payment, you also use the money you get from a mortgage loan to make up the rest of the price of the house. We are going to assume you are getting a mortgage in addition to your down payment, as that is what most people do (in fact, over 70% of home purchases have a mortgage, and over 90% of home purchases by buyers under 55 have one!).*
You may also see or hear the term "loan-to-value" ratio. This is the percentage of the purchase price of your home you are taking out as a loan, which is the inverse of your down payment. So if you have a loan-to-value of 90%, that means you are putting down 10%.
With that out of the way, let's get down with down payments!
Why does my down payment matter?
Lots of people talk about down payments, but why do we actually need to talk about them? In short, your down payment is one of the major factors in determining how expensive a home you can afford, how much you have to borrow to buy that home, and how much it will cost you. That's a lot of things your down payment impacts. Let's break it down.
1. Your down payment determines how much you have to borrow to buy your dream home. It's pretty straightforward: the more you put down, the less you have to borrow in your mortgage. The less you borrow, the less interest you pay, the more competitive your offer on a house can be, and the more money you will save over the lifetime of your mortgage (typically 30 years).
2. Because your down payment affects how much you have to borrow, it also determines how much your new monthly housing payment will be. When you borrow more, you have to pay more on your mortgage every month - meaning that the more you put down, the less you have to pay each month in principal and interest on your loan. This is a huge driving factor for people to put down more on their house than the bare minimum. It can save you tens of thousands of dollars in interest and make it easier to cover other expenses every month.
3. Your down payment amount determines extra costs you have to pay. There are many costs tied to down payments, and typically the less you put down, the higher these costs are. The two biggest ones are mortgage insurance and loan level pricing adjustments. Mortgage insurance is usually required on any mortgage where you put less than 20% down on the home, and it can cost you hundreds of dollars a month. This money does not go towards your mortgage but is spent protecting the lender's interest. It can be very costly over the life of your loan.
The lesser-known hidden cost of putting less down on a house is loan level pricing adjustments. Loan level pricing adjustments are changes to your interest rate that lenders apply based upon different factors in your application, such as your credit score and your down payment percentage. This can result in considerable differences in interest rates; for example, on a conventional mortgage, a borrower who puts down 3.5% has a 0.75% higher interest rate compared to a borrower with the same credit score who puts down 40%.** On a 30-year $300,000 mortgage, that is a difference of over $40,000 in interest paid!
Finally, your down payment is one of the biggest factors in determining how much house you can afford. This is driven by the minimum percentage you have to put down based on the loan programs you qualify for. For example, if you have $10,000 saved for a down payment and the programs you qualify for say you only have to put 5% down on a home, you can afford a $210,000 home. However, if they say you have to put 10% down, you can now only afford a $110,000 home. How do you know what percentage you have to put down? Let's dig into that in the next section.
How much do I have to put down on a house?
One of the most common questions about down payments, and you have probably heard a lot of different answers! One of the most common answers is "you have to put 20% down on a house". At the same time, many people also hear, "you DON'T have to put 20% down on a house - you can put as little as 0% down!" The most confusing part? They are both right!
Down payments are like snowflakes - every person's down payment requirements are different. That said, two major factors determine how much you have to put down on a house: the loan programs you qualify for and your debt-to-income ratio.
Loan programs are a fancy way of saying different types of mortgages. There are hundreds of loan programs across hundreds of lenders. In general, the main loan programs come from government entities like Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA). Most lenders offer these programs, and they can even offer programs that work on top of these government ones - for example, they can offer an FHA loan with an even lower down payment option by combining loans.
Every loan program will spell out exactly how much you have to put down. Typically called the maximum loan-to-value ratio for the program, which is just the inverse of your down payment, as we learned at the beginning of this post. Programs don't necessarily have a single maximum loan-to-value ratio, though. Typically, they will have different maximum ratios that depend on aspects of your application. For example, if you have a lower credit score, the program may require you to put more down on the house.
Your credit profile, home price, location, whether or not you are a veteran, and other factors determine which loan programs you can qualify for. These programs can have down payment requirements as low as 0%, but some can have 20%+ requirements. Here are two examples on each end of that spectrum:
- If you are buying a home in a qualified rural area and have income below the USDA's maximum for that area, you may be able to get a USDA mortgage with as low as 0% down.
- If you are buying a very expensive home for your area with a big mortgage (often called a "jumbo loan"), you may have to put as much as 20% down.
As you can see, these situations get very specific, which is why there are so many loan programs. Understanding the programs you qualify for is critical to figuring out how much you have to put down.
The other major factor determining how much you have to put down is your debt-to-income ratio. We have a whole post on what debt-to-income ratios are, why they matter, and how they are calculated here. In short, it is a measure of how expensive your mortgage is relative to how much you make.
This ratio is important because every loan program also has a maximum debt-to-income ratio that you can have. It determines how much you can borrow. Even if the loan program allows you to put 0% down, your debt-to-income cannot go over the limit set in the program, which can force you to put much more down.
The mixture of these two restrictions can be confusing, so let's walk through a quick example. Let's say you wanted to buy a $500,000 house, and you qualified for a loan program that allows you to put 0% down. However, the program also has a debt-to-income restriction that you can only qualify for a $300,000 mortgage. Because of that restriction, to buy the $500,000 house, you would have to put down $200,000 ($500,000 minus the $300,000 mortgage you qualify for). This means that even though the program allows you to go as low as 0% down, you have to put 40% down!
As you can see, figuring out how much exactly you have to put down on a home is not an easy task. Adding to the complexity are all of the other costs you have to save for.
What other costs do I need to save for?
Down payments are the most talked-about part of saving for a home, but there are several other costs that are equally important. These costs often surprise people and can cause you to no longer be able to afford the home you put an offer on.
Some of the most forgotten costs in buying a home are closing costs and reserves. Closing costs are fees you pay at the time of closing on your home. These include loan application fees, real estate attorney fees, credit report fees, escrow fees, and homeowners association transfer fees. These costs add up, but thankfully your lender is legally required to disclose an estimate of these costs to you after you submit an application. These are costs you have to pay out of pocket, so it's important to save for them!
The other major expense that is often forgotten but you may need to save for is reserves. Reserves are not an actual expense - you don't actually have to pay anyone the money - but it is money that a lender may require you have on hand. Typically, reserves are expressed as months of your new total monthly housing payment (aka your mortgage payment plus typical other expenses, like mortgage insurance). For example, if a lender says you need three months of reserves on a mortgage where the monthly housing payment is $1,000, that means you not only need the down payment for that loan saved, but an extra $3,000 for the reserves as well!
Reserves are not required on all loans, but they are more common on jumbo or high-balance loans and loan programs that allow people with lower credit scores to get a mortgage. This is because having those reserves reduces the risk that you cannot make a payment on your mortgage, as you have shown you have the money to do it.
You may need to save for other costs, but closing costs and reserves are typically the largest ones and can derail you from getting the home you want. Just knowing how much to put down is the start; figuring out how to build that down payment is the hard part!
How do I build up a down payment?
Building a down payment is hard. In fact, saving for a down payment is typically the most challenging part of buying your first home! Beyond just saving money, there are other ways you can build a down payment. Below are a few of the most common.
First, there are down payment assistance programs. Down payment assistance programs are programs run by organizations, lenders, or governments that help you get enough money to put down on a home. These programs can take many forms, but typically they are structured as second mortgages. A second mortgage is exactly what it sounds like: it's a second loan you are taking out to be able to buy your home (just like how your normal mortgage could be called your first mortgage). These programs lend you money that you can use for your down payment in addition to your own money so that you can afford your desired home.
That said, not all down payment assistance programs are created equally. These programs usually run as either forgivable or non-forgivable. Forgivable programs are those where you can have a portion of the second mortgage forgiven - that means you don't have to pay it! Usually, the forgiveness has strings attached to it, such as staying in the house for a minimum of 3 years. Non-forgivable programs are the exact opposite - you have to pay back the amount that the down payment assistance program provided you. Sitting in-between the two is partial forgiveness programs. Partial forgiveness programs are when you can have a portion of the second mortgage forgiven if you meet certain requirements.
Down payment assistance programs can have many requirements. The most common ones are caps on how expensive the home you can buy (based on average prices in your area), income caps that disqualify you if you make more than a certain amount, and requirements that you are a first-time homebuyer.
Another common way to get help building a down payment is a gift from a relative or friend. While not everyone has access to this, close to a quarter of homebuyers between 22-30 years old receive some amount of money as a gift to help pay for a down payment.* There are a lot of rules around gift funds, though, including special ways to document the money and transfer it. It's also important to note that gifts from people other than close friends and family are typically not allowed.
Beyond gifts and down payment assistance programs, saving money for a down payment requires budgeting carefully and ensuring you put away enough to afford the house you want. This means using tools that understand your goal of homeownership and can help you properly figure out how much you should save for a down payment.
How much should I save for a down payment, then?
Between all of these rules, loan programs, down payment assistance requirements, and everything in between, it can be difficult to figure out how much you can put down, not to mention how much you should put down. To figure this out it's important to understand first the tradeoff of putting more or less money down and having the tools to help you set the right path.
First, let's talk about the tradeoff of putting more or less down on a house. As we talked about above, the more money you put down, the less interest and fees you typically will end up paying. Additionally, your monthly payment will usually be lower, helping you save more money monthly. However, the more you put down, the more cash you tie up in your house. This is money you could be using elsewhere, whether for saving for a rainy day or putting it into investments that could grow faster than your home's value.
You also only have a fixed amount of savings, so the higher the percentage you put down on a house, the less expensive of a home you can afford. While it is usually not best to overextend yourself and wind up with an unaffordable monthly payment (what some people call "house poor"), you also want to make sure you get the house that will satisfy your needs and is a good investment.
With these tradeoffs in mind, it's important to figure out your options. This requires comparing your finances with the hundreds of loan and down payment assistance programs, figuring out how much you can save monthly, assessing your credit situation, and how you can make the tradeoff on putting more or less down. That's a whole lot of stuff to figure out!
This is why we built Quo - Quo is a mobile app that connects directly to your finances to find the best path to your dream home. It automatically assesses loan programs with your real finances to figure out your best path to homeownership. Quo let's you see exactly how much you need to save for a down payment based on your desired zip code and home size. Plus, it finds shortcuts like paying down debts rather than saving to boost your debt-to-income ratio. Quo gets you into your dream home even faster by constantly monitoring your credit, savings, and more to ensure you are on the best path to homeownership.
Download the Quo app today to get your personalized path to homeownership.
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