A down payment is the amount of money you pay up front when buying something with a loan; like a car or in this case, a home. Here’s a quick example: if you want to buy a home that’s worth $250,000 you’ll need to pay that full $250,000 but you probably won’t borrow that full amount. You’ll probably pay some of that up front, and borrow the rest. If you can come up with $25,000 in cash for a down payment you’ll only need to borrow $225,000. So your down payment is 10% and you borrow the remaining 90% as a mortgage.
The typical range for a mortgage down payment is from 5% to 20%. Generally speaking the higher the down payment percentage, the better mortgage interest rate (i.e. lower rate) you’ll qualify for. It’s a sign to the mortgage lender that you’re (literally) invested in that property and means they would lose less money if they have to foreclose. For a given house price (again let’s use $250,000) the higher the down payment you’re able to make, the lower your monthly payment will be as well, since you’ll be borrowing less. The monthly payments will be lower if you’re only borrowing $200,000 compared to borrowing $225,000. (a 20% down payment versus a 10% down payment.)
There are some other important numbers to know.
If you put less than 20% down, you will probably have to pay PMI, or Private Mortgage Insurance. This is a monthly fee that is tacked on to your mortgage payment but doesn’t go towards principal or interest, it’s extra money you’re paying the mortgage company because of their increased risk due to the low down payment. The annual total you’ll pay in PMI is usually between 0.5% and 2.5% of the total loan amount. So if you only put down 10% on a $250,000 home you’ll be paying $25,000 up front and borrowing $225,000 and will be paying for PMI. At 0.5% a year, that means you would be paying an additional $1,125 (or almost $100/month) every year until the PMI is no longer required. PMI is automatically removed when your Loan To Value Ratio (the amount owed on your mortgage divided by the value of the home) reaches 0.78. In our example, the LTV at the start of the loan was $225,000/$250,000 = 0.9, or 90%. When you’ve paid it down to where you only owe $195,000 the PMI would automatically be removed ($195,000/$250,000 = 0.78).
5% is usually the lowest down payment accepted for a conventional mortgage, but there are exceptions.
FHA loans (mortgages insured by the Federal Housing Administration) are intended for home buyers that would have difficulty qualifying for traditional mortgages. Down payments as low as 3.5% are accepted for buyers with good credit scores, those with lower scores will need 10% down.
Down payments of 3% and lower (even 0%) are available in some cases. Service members, whether active or retired, may have access to zero down payment programs through the Department of Veteran’s Affairs. If you live in a rural area you may qualify for a zero down payment loan through the U.S. Department of Agriculture.
The key thing to remember are that the larger the down payment, the better the terms you’ll get on your mortgage, generally speaking. You’ll borrow less, possibly at a lower rate, and will therefore pay less in interest over time. But you don’t want to completely drain your savings to