Imagine the process of financing a home purchase as a relay race. From start to finish, the baton must be passed several times between interconnected transactions. The down payment plays an important role in the relay race and will help you cross the finish line, but how much money do you put down? And when do you make the down payment? Understanding its characteristics will help you see where it fits in the home buying process.
What is a down payment?
The down payment is a large payment made upfront to help fund a home purchase. Unlike the financing obtained through a mortgage loan, the down payment comes out of the buyer’s pocket, not from a lender.
For example, let’s say the house you want to buy is priced at $500,000. If you put $25,000 down, or five percent of the purchase price, that would leave $475,000 you’d need to pay for with a mortgage. If you put down $100,000, or 20 percent, that would leave a $400,000 mortgage principal. In general, a higher down payment equates to a lower interest rate since that financial structure is viewed as less risky by lenders. It also means your monthly payments will be lower since your loan balance is smaller.
However, making a large down payment isn’t feasible for everyone. In fact, according to the National Association of REALTORS® Profile of Home Buyers and Sellers1, the typical down payment was seven percent for first-time home buyers and 17 percent for repeat buyers in 2021. If you’re not able to put down 20 percent of the home’s purchase price, your lender will typically require that you obtain Private Mortgage Insurance (PMI), which protects them against the possibility of a mortgage default. The benefit of PMI is that it creates a pathway to homeownership by allowing you to move in and start building equity right away.
Different loan products have different down payment requirements. Conventional loans have a minimum down payment requirement of three percent, while government-backed loan products like VA loans or USDA loans may allow you to purchase a home with no money down if you qualify.
Down Payment: Home Monthly Payment Calculator
As you prepare to buy a house, it’s helpful to see what you can afford. Your down payment will have a direct impact on your loan terms and your monthly mortgage payment. Use our Home Monthly Payment Calculator to experiment with different down payments, principal amounts, interest rates, taxes, and more for any listing price.
How to Save for a Down Payment
Though your lender will need to verify that you have the funds available to make your down payment early on in the mortgage approval process, the down payment is officially due at closing. Saving up for such a payment may seem like a daunting task, but with the right planning, you’ll make steady progress. Having a strategy in place for compiling your down payment is a telltale sign that you’re ready to buy a home. Here are some methods of generating savings to consider:
- Consider downsizing to reduce your living expenses and increase your savings over time.
- Reduce your debt before applying for a mortgage to give yourself a better shot at favorable mortgage terms—i.e., a lower down payment requirement and reduced interest rates.
- Explore down payment assistance programs to see if you qualify.
- Ask family members for support.
If you’re in the process of selling your current home while looking for a new one, know that you can use the proceeds of the home sale to help finance your new home purchase.
For more information on financing a home purchase, helpful tips on the buying process from start to finish, and more, visit our Home Buying Guide.
1. National Association of REALTORS® (2021) Profile of Home Buyers and Sellers
Featured Image Source: Getty Images – Image Credit: ridvan_celik