What Is the Right Down Payment on a House?
Point of Interest: Down Payments
Figuring out how much money you should put down on a home is an important step in the home buying process. The standard amount has been 20%, the real answer is that it depends on a number of unique factors specific to your situation. Dedicate some time to analyzing the short term and long term effects of different mortgage down payments on your upcoming home purchase.
One of the most common questions potential home buyers ask — and rightfully so — is “how much should I put down on a house?” While it can be tempting to put down the minimum amount required, there are some instances when a larger down payment is a smarter move for you and your family. You only have one opportunity to put down a down payment on a home loan, so it’s important you ensure you’re choosing the right amount.
What is a down payment?
A down payment is the portion of the home price that you choose to pay in cash upfront. The remaining balance due on the home sales price is the amount that gets financed through a loan.
For example, if you are looking to purchase a $300,000 home, you will almost always be required to pay a percentage of the total cost in cash to secure your loan. If you decide to make a 5% down payment, for example, you will pay $15,000 — or 5% of the total cost of the home — upfront. Your loan amount will cover the remaining cost of the home. In this case, the loan would amount to $285,000, because $300,000 – $15,000 = $285,000. You’ll have the option to pay well over the minimum, but most lenders won’t be flexible if you’re trying to pay less than the required down payment amount.
Down payments serve several purposes. First, they demonstrate to lenders that you’re financially sound enough to be making this purchase. If you’re unable to offer even a small percentage of the purchase price, lenders may begin to question if the home is within your budget. The down payment weighs into their configurations of your creditworthiness.
The down payment also helps to lower the amount of the purchase that you need to finance. This can affect the interest rate you receive, the size of your loan payments, the length of your loan and what types of loans you qualify for.
How much should I put down on a house?
The answer to the question of how much you should put down on a house, you’ll need to take into account three things — the required minimum, what you can afford and what your goals are. Each type of loan has a required minimum down payment percentage you’ll need to put down. Different lenders will use different methods of configuring the minimum, but you should know that these minimums are usually hard numbers, and you won’t be able to negotiate any lower.
For example, a Federal Housing Administration (FHA) loan will have a minimum down payment of 3.5%. If you are purchasing a $300,000 home, you’d pay 3.5% of $300,000 or $10,500 as a down payment when you close on your loan. Your loan amount would then be for the remaining cost of the home, which is $289,500. Keep in mind this does not include closing costs and any additional fees included in the process.
According to the National Association of Realtors 2019 report, the average amount of the home price financed last year was 88%, meaning the average down payment was 12%. If you were purchasing that same $300,000 home, your down payment would be $36,000.
You’ll also need to weigh what you can afford and what your goals are. Each situation is unique, but the general rule is that as your down payment goes up, you’ll be able to secure better interest rates and more favorable loan terms. You’ll want to compare things like interest rate, payment size and the types of loans you’re able to secure with the payment amounts you can comfortably afford.
In general, the industry standard has been a 20% down payment. Many new types of loans have been introduced recently and there is more competition amongst lenders, so this figure might be a bit antiquated. The exact percentage you’ll want to put down is best determined on a case by case basis.
Should I buy a home with a low down payment?
It depends. If you’re able to secure the interest rate and loan terms you want with a smaller down payment, it might be something to consider.
“The pros and cons of low down payment loans vs. loans with larger down payments all boil down to what the available interest rates are. If rates are low, then the cost of borrowing is cheap, and therefore, it would be wiser to take advantage of available low down payment loans,” Adam Supraski, real estate broker with Fortress Realty, said. “On the other hand, if interest rates are high, it might be wiser to make a larger down payment.”
If you’re just beginning your financial journey through life, a lower down payment may be the only option to purchase a home. If this is the case, make sure to have an honest discussion with yourself about whether it may be better to wait until you have the ability to make a larger down payment.
Benefits of a large down payment
Making a larger down payment on a home purchase carries quite a few benefits potential home buyers should be aware of.
1. Avoid PMI insurance
Private mortgage insurance (PMI) is a type of mortgage insurance required by lenders when a buyer requests a conventional loan and makes less than a 20% down payment. There are instances when you’ll be allowed to make a smaller down payment and avoid PMI, but you will almost certainly get a higher interest rate in return. Once you’ve reached 20% equity in your home you can request your lender remove the PMI. Regardless of their response, PMI must be removed when your loan balance drops to 78% of the home’s original appraised value.
2. Pay less in interest
When you make a larger down payment on a house, you lower the amount of money that needs to be financed. You’re only paying interest on the money you need to borrow, so this will lower the overall interest expenses you incur over the life of your loan. In other words, a larger down payment will lower the overall cost of your house.
3. Lower monthly payment
A larger down payment is going to lower the amount of money you need to borrow, which will in turn lower the amount you owe per month on your mortgage. It could also give you the ability to pay more each month and pay off your loan in a shorter period of time. The bottom line is that a larger down payment will open up more repayment options.
What is the right down payment amount for me?
To get the best answer to this question, conduct an honest assessment of what price of the home you want, the size of down payment you can comfortably afford and what your ideal monthly payment and interest rate looks like. Once you’ve compiled all of this information, begin shopping different lenders to see what they’re able to do for you.