How big should your down payment be?
When home prices rise, so do the down payments required to purchase those homes. This has long posed a roadblock for many would-be first-time homebuyers. But it doesn't have to be the case.
Our real estate agents share everything you need to know about making a down payment on a home.
A down payment is simply the part of the home's purchase price you pay upfront. It might be the biggest check you ever write in your life, and the amount you pay could impact your finances for years, if not decades.
Contrary to conventional wisdom, you don't have to put 20 percent down on a house. There's no law or rule for a universal minimum down payment. The amount you should put down is a personal decision that depends on what's best for your finances. Lenders require homebuyers to make a down payment for most mortgages. For instance, the amount is usually 3% of the home's price for conventional mortgages.
On that note, most lenders will require a down payment of 20 percent to avoid paying private mortgage insurance (PMI)—in case you're wondering where the 20 percent number comes from. Far from most types of insurance, this legally binding document protects the lender's vested interest in the home, not the homeowner.
When you make a down payment of less than 20 percent, your mortgage loan-to-value (LTV) ratio is over 80 percent. As such, you present a higher risk profile to the lender, which necessitates purchasing private mortgage insurance to offset this risk. PMI will increase your monthly mortgage costs until you have accumulated enough equity in the home that the lender no longer considers you high risk. So, there are advantages to making a larger down payment.
Another advantage is lower interest rates. A solid down payment may signify that you're less likely to default on your loan, which may prompt lenders to reduce your mortgage interest rate. Even saving a fraction of a percent on your interest rate could save you thousands of dollars over the life of your loan. Still, your overall interest will depend on factors other than your down payment, such as credit scores, home price, and loan term.
As mentioned, down payment requirements vary depending on the type of mortgage you qualify for. For instance, if you qualify for government loans, your down payment may be as low as zero.
There are several options for a mortgage with no or low down payment:
It's important to weigh your mortgage options before committing to a down payment amount. Even though a 20 percent down payment is ideal, you shouldn't fixate on it. The right amount depends on numerous factors, including how much you can comfortably afford. You don't want your down payment to be so large that it leaves you with too little savings.