How Much Do You Need for a Down Payment to Buy a Home?
There are advantages to putting down 20% but it is not always required
How much of a deposit do you need for a house? Most people who are looking to buy their first homes want to find a loan that requires the smallest down payment possible.
Maybe you've been saving and you have about $2,000 tucked away so far. Friends and family are telling you that you should try come up with a down payment of at least 3% of your targeted home's sale price. That's a $6,000 down payment on a $200,000 home, and it feels doable.
But others are telling you that you should aim for 20%—or $40,000 for that same house! How much of a down payment is really required to buy a home?
Where to Get That Kind of Money?
Conventional wisdom says that you should put down as much as you feel comfortable with. More is generally better than less, but you don't want to wipe out your savings account to do it, either. You'll still need funds set aside for a rainy day and for the things you'll want to purchase after you buy your home.
Fortunately, you have some options for leaving your savings account at least somewhat intact.
- Gifts or loans from family: Be aware, however, that you might have to account for this money when you're qualifying for a mortgage.
- Take out a personal loan: This one can be tricky because you're effectively taking out one loan for the purpose of taking out another. In fact, some lenders won't allow this. Even if yours does without batting an eye, taking on additional debt will increase your debt-to-income ratio, which can then disqualify you for that mortgage.
- Loans or withdrawals from retirement accounts: "Loan" is the operative word here. If you take a withdrawal from your IRA or 401(k), the IRS can look at it as a taxable event and you might pay an early withdrawal penalty besides, depending on your age. The good news is that there's a first-time homebuyer's exemption. You can take up to $10,000 from your retirement account penalty-free if you qualify.
- Sale of other assets: A garage sale probably won't do it, but you can potentially raise some cash if you have any big-ticket items or investments you're willing to part with.
Nearly eight of every 10 homebuyers use their savings for a down payment for a home.
Down Payment Assistance Programs
Another option is to qualify for down payment assistance, if possible. The Department of Housing and Urban Development offers first-time homebuyer grants if you qualify. Check with your county to find out what's available in your location, keeping in mind that there are typically income and sometimes credit score restrictions. You might also ask your potential lender about available assistance or grants.
Only certain lenders are able to approve you for a mortgage if you're receiving assistance for a down payment.
Types of Minimum Down Payments
The amount of your minimum required down payment will depend on the type of loan you choose. Each mortgage type carries its own guidelines, and underwriters will closely scrutinize your ability to repay the loan. They don't want you to overextend yourself and end up in foreclosure or a short sale down the road.
- VA loans: VA loans were created by the government in 1944, and they're one of the best deals going in America. They offer competitive rates and attractive terms. The best thing about a VA loan? No down payment. That's right. Zero down. But you have to be a past or present member of the Armed Forces to qualify.
- FHA loans: This is another government program, and it's been around even longer than the VA program. FHA loans have been part of the American mortgage system since 1934. The minimum down payment requirement is 3.5%. There's a mortgage insurance premium, but it can be folded into the loan.
- Conventional loan: Most conventional loans are fixed-rate mortgages, and most don't have fast-and-firm down payment requirements. Although 100% loans aren't available, you might qualify for as little as a 3% down payment if you have a pretty good credit score. And some special conventional loans for certain classes of professional people, such as teachers, can require zero down.
The 20% Rule
You've no doubt heard that you must put down 20%, but that's not the whole story. You can find 10% and 15% down payment options or even less, as in the case of FHA loans. But anything less than 20% invariably requires that you pay private mortgage insurance (PMI), even on FHA loans.
Lenders look at it this way: You have a pretty significant personal financial stake in the property if you put down 20% or even more. That makes it less likely that you'll default and risk foreclosure. That 20% is your money and you don't want to lose it.
Lenders want some assurance if you put down less—not necessarily that you won't default but that they'll still get paid if you do. A PMI policy effectively insures the bank. It will get paid in a worst-case scenario.
PMI rates can vary. They're based on a percentage of how much you're borrowing, and they're included with your monthly mortgage payment, increasing it—at least until you build up 20% equity in your property. You can usually cancel the insurance at this point. You won't have to pay PMI if you can afford to put 20% down.
Down Payment vs. Earnest Money
Don't confuse a down payment with an earnest money deposit. A down payment is a percentage of the sales price you'll pay out of pocket—it's the portion you're not borrowing. The remainder of the purchase price after your down payment is the amount of your mortgage.
An earnest money deposit is paid to secure a purchase contract. It's part of your down payment, and the amount is generally dictated by local home buying customs. An earnest money deposit can vary from as little as $100 or $500, to $1,000 or even $50,000, depending on the property's sales price.
Paying earnest money shows that you have good faith intentions to buy the home you're putting an offer in on. Earnest money is generally 1% to 3% of the purchase price. You can potentially lose the money if you default on the contract and decide not to purchase the home after your offer has been accepted by the seller.
Buyers who put down a larger earnest money deposit often gain an advantage in multiple-offer situations. Sellers tend to see a big earnest money deposit as a sign that a buyer is committed and serious and will go through with the purchase.
Why More Can Be Better
- Some lenders will reward you with a lower interest rate if you make a more significant down payment.
- Sellers who are entertaining multiple offers on a choice piece of property tend to favor offers with larger down payments.
- Your monthly payments will be less if you put down at least 20%, not only because you won't have to pay PMI but because you'll be paying interest on a smaller sum and the principal that you're stretching out over the mortgage term will be less.