Considering buying a home? You’ve come to the right place. We’ll walk you through the basics of down payments and talk about the pros and cons of putting more money down. Then our down payment calculator can help you decide how much of your hard-earned savings you should consider putting toward a down payment—and how much to set aside for a rainy day.
What is a down payment, anyway?
A down payment is cash that you pay up front before the mortgage starts. It’s money that signals to the lender that you’re a good candidate for a mortgage: you’ve managed to save up some money, and you care enough about the home to put a chunk of your savings toward making it yours.
Is 20% the magic number?
Actually, yes. Put any less than 20% down and you’ll have to find a way to secure the mortgage, either through insurance or a second loan. Exceptions to this are those who qualify for special home-buying assistance like the VA Home Loan, which helps veterans become homeowners without putting any money down. But ideally, buyers will have 20% of the value of the home saved up for the down payment.
No down payment? No problem—maybe
Before the 2008 financial crisis, lenders allowed many Americans to put little or no money down when they financed a home purchase. Some first-time buyers had mortgages equal to 100% of the home value.
We all know what happened next. Defaults on these no-money-down mortgages contributed to the Great Recession, and left some families facing foreclosure. In the wake of the crisis, lenders tightened their credit requirements and demanded higher down payments before helping buyers finance home purchases. Everyone swore we would never go back to the bad old days when people could put only 1% down and still secure a 30-year mortgage.
Now, though, the tide has turned again, and low- or no-down payment home buying appears to be back. 3.5% is usually the minimum down payment on a mortgage, but there are several choices for buyers without much cash on hand. Don’t have a lot to spend on a down payment? Check out the next section to see what your options are.
Big spender? Skip ahead to see if putting more than 20% down could be your best bet.
0-20% down: risky but doable
Want to buy a home but can’t scrape together the full 20% down payment? You’ve got options.
- Option 1 is to see about a gift from a relative or friend to help you get to that magic 20% down payment amount. Asking loved ones for money can be tough, but if you explain that putting more money down will save you thousands in interest payments over the life of the mortgage, you might get the help you need.
- Option 2 is to put less than 20% down to secure a first mortgage on the home itself and use a second loan to finance the difference between your contribution and the 20% mark. This second loan is known as a piggyback loan, and will typically come with a higher interest rate than the first loan. Piggyback loans went out of fashion during the financial crisis but they’ve since made a comeback. With a piggyback loan, you’ll be asked to put 5%, 10%, or 15% down for a first mortgage that covers 80% of the home value. Then your second loan, the piggyback, will finance the difference between what you have and the 20% target. So if you only have 5% to put down, you’ll be looking at what’s called an 80/15/5 loan. Your first mortgage will cover 80% of the home value, your second mortgage will cover 15%, and you’ll be on the hook for that last 5%. If you have 15% of the home value to put down, you’ll need an 80/5/15 loan. You get the picture.
- Option 3 is what’s called private mortgage insurance (PMI). If you’re putting less than 20% of the home value down, your lender will want to insure your mortgage in case you run into trouble keeping up with the payments. Many private insurance companies offer this kind of mortgage insurance. As the buyer, you will be on the hook for the insurance premium, but the lender will be the beneficiary should you fail to make your mortgage payments. How much will those premiums run you? Insurance companies generally charge between 0.3% and 1.15% of the loan amount annually.
- Option 4 is to see if you qualify for a loan backed by the Federal Housing Administration. SmartAsset’s online checklist can tell you whether or not you qualify for an FHA-approved loan, and what’s the maximum home value you could finance with an FHA loan in your target area.
- Option 5 is to apply for a Wealth Building Home Loan (WBHL). This a relatively new program designed to help low-income Americans build home equity faster than they would with a traditional 30-year loan. With a WBHL you can use any savings you have to buy points that will reduce your mortgage interest rate. Depending on how much money you can put toward buying points, your interest rate could go as low as a fraction of a percent. That means that your monthly payments will be going almost entirely to equity, not to the bank. You’re essentially paying yourself to invest in your home.
- Option 6 is to seek a USDA home loan—if you’re willing to live in a rural area, that is. The Department of Agriculture backs mortgages that require little or no money down to applicants willing to live in designated rural areas and whose incomes are 115% or less of the median income in that area.
- Option 7 is to check out down payment assistance opportunities through your state government. Many states offer interest-free loans to low- and moderate-income first-time homebuyers. These loans can be applied to down payments or to closing costs.
Phew. Got all that? Good.
Does it pay to put more than 20% down?
That depends. One benefit to putting more money down is that it gives you the power to negotiate a lower interest rate with your lender. That’s because your investment in the higher down payment shows that you have plenty of money and that you’re committed to building equity in the house, so the lender sees you as more likely to keep up with your mortgage payments. Banks like that. Another benefit is that the more money you put down, the less you borrow, meaning you’ll pay less in interest payments over the life of the loan. You get to keep more of your money and the lender gets less of it.
Sound like a no-brainer? Not so fast. Say you have a mortgage loan with a 4% interest rate. If you put more money down you’d save yourself the 4% interest on that chunk of change—money that would otherwise go to the bank. If you didn’t put that extra money toward the down payment, though, you might be able to get returns above 4% if you invested the money in stocks and had the patience to let it grow over time. In other words, there might be places to put your money that would be more profitable.
Whether you decide to put more than 20% down depends a lot on how badly you want to beat out the competition for the home, whether you think your savings could do more for you invested elsewhere and how soon you want to build equity, pay off the mortgage and be debt free. For people with extra cash and a low risk tolerance, making a larger down payment may be the best option. If you have high-interest debt from credit cards, though, you’d be better off putting any extra savings toward paying off that debt.
What if I want to pay all cash?
Fancy! In today’s real estate market, it’s not uncommon for people to make all-cash offers on homes in particularly competitive markets like New York City and Boston. If you need to move quickly and money is no object, an all-cash offer—aka a 100% down payment—may be your best bet to get the home you want.
Most mortals, though, will need a mortgage to help them finance a home purchase. And even those lucky enough to have the entire home price in liquid assets should still weigh the benefits of making an all-cash offer against the costs. Would investing that extra money yield a higher return than putting the money into your home purchase? Depending on how you’re investing, the answer could be yes. You also have to ask yourself if you’re prepared to run the risk that a crash in real estate prices could leave you with a depreciated house that you own outright and can’t sell for anything close to the price you paid. Not a good feeling.
Another factor to consider? Real estate leverage. If you pay cash for a $200,000 house that appreciates to $300,000 by the time you want to sell, you’ll have made $100,000 - a 50% return on your investment. Not bad! Your neighbor who bought the same house after putting only $40,000 down, though, will make that same $100,000 (minus interest payments over the interim), but with a much higher return on investment.
The more money you put down, the more invested you are in the home—in good ways and bad. You own more equity and owe the bank less, but you’re also more vulnerable if the market crashes, and your real estate leverage is less than it would be if you went with the standard 20% down payment.
How much money should I leave myself after closing?
While it may be tempting to max out your down payment by turning over all of the money you’ve worked so hard to sock away, we recommend you leave yourself at least three months’ worth of mortgage payments in savings. That way, if you run into emergencies such as a job loss or illness you’ll have a cushion to help you keep up with your mortgage payments. A down payment calculator will help you figure out how much money to put down, and will never leave you without that three-month cushion.
If you’re already thinking about a down payment, you’ve probably also done some thinking about how much house you can afford, your expenses and how much debt you’re willing to take on. Remember, the down payment is the beginning, not the end. You’ll need to ensure that your monthly mortgage payments are within your budget, and you’ll have to plan for expenses like property taxes, utilities and maintenance on your new home.
Happy home buying!