One of the major obstacles for first-time home buyers is saving for a down payment. It’s a major undertaking. However, it doesn’t have to be overwhelming and you may not need as much as you think.
This post will take you through how much you really need for a down payment to buy a house, what the right down payment is for you and some frequent misconceptions. Before we go much further, let’s cover a basic question.
What Is a Down Payment?
A down payment is a certain amount of money, expressed either as a percentage of the purchase price or as a flat amount, that is paid up front for a good, service, loan or piece of property. Although the rest of this post will reference a down payment in terms of getting a mortgage to buy a house, there are lots of other circumstances in which a down payment is made.
In addition to a down payment for a mortgage, you might also have an upfront payment you make on a car loan or money you put upfront for furniture or other high-value items. A contractor might ask to have a certain amount paid in advance before being paid the rest at various stages of the work.
For the purposes of what we’ll discuss today, the down payment we’ll be referencing will be the amount needed in order to secure a mortgage with various loan types.
Can You Pay Less Than 20% for a Down Payment on a Mortgage?
The short answer is yes. An old, common misconception is that you need to have 20% down in order to buy a home.
That naturally lends itself to other questions. Two that immediately come to mind are “What’s the real minimum?” and “Are there any advantages to a higher down payment?”
What’s the Minimum Needed for a Down Payment on a Home?
The minimum amount needed for a mortgage down payment will depend on the type of property you’re trying to buy and which mortgage investor is backing your loan. Let’s break this down.
Primary Residence
If you’re looking to get a one-unit primary residence – the place where you plan to spend the majority of your time – you’ll normally need a down payment of between 3% –5%.
There are a variety of 3% down options for conventional loans. Let’s run through them.
Quicken Loans offers a 3% down option generally available for those who make no more than their area median income. You can also qualify for a 3% down loan if you’re a first-time home buyer, which is defined as someone who has not owned a residential property in the last three years prior to purchase.
The mortgage investor Fannie Mae also has a special program available for first-time home buyers who purchase one of the foreclosures Fannie Mae owns. They can purchase with a 3% down payment and get up to 3% back in closing cost assistance in the form of seller concessions. In exchange, you just take a first-time home buyer course.
To get any kind of conventional loan, you need at least a 620 median FICO® Score. Even if you don’t qualify for any of the programs above, in most cases, you wouldn’t be required to make more than a 5% down payment for a conventional loan on a one-unit property. Multiple units – up to four – would require a higher down payment.
An FHA loan requires a median 580 FICO Score and a 3.5% down payment. A key advantage of the FHA loan option is that if you have a higher credit score, you may be able to qualify with a higher debt-to-income ratio (DTI). This means you could afford more home than you would under other loan options because you could be qualified with a higher monthly mortgage payment. This could be an advantage if you needed the space but didn’t have 20% in the bank for a down payment.
You can get a one-unit primary property with a USDA loan without putting any money down. Intended to spur rural development, these loans can be used for homes in rural areas or on the outskirts of suburbia. You just can’t live on a working farm. There are also income restrictions and your adult household members can’t make more than 115% of the area median income. Finally, you need a 640 median FICO Score.
VA loans are available for eligible active-duty service members, reservists, veterans and surviving spouses of those who were killed in action or passed away as a result of a service-connected disability. No down payment is required, and VA loans often have some of the best rates available. You can also purchase a house with up to four units if you have aspirations of renting out the other three.
Second Home
If you’re getting a second or vacation home, you have to get a conventional loan. The minimum down payment in this case is 10%. In order for something to qualify as a vacation home, you need to live in it for a significant amount of time each year. Also, while it may be rented out, you can only do so for up to 180 days.
Here’s more on second homes.
Investment Property
If you buy a piece of residential property for the sole purpose of renting it out, it’s considered an investment property. These are all conventional loans and will require a higher down payment than primary properties or second homes because mortgage investors know you would make the payment on homes you live in first if you were ever to get into financial trouble. These loans also come with a higher interest rate. It’s possible to get a one-unit investment property with a 15% down payment through Quicken Loans if you have a median FICO Score of 720 or higher. If your FICO Score is lower or you want more units, it’s a 20% or 25% down payment.
What Are the Advantages to a Higher Down Payment?
Now that we’ve highlighted low down payments, let’s go over why a higher down payment might make sense if it aligns with your financial goals.
Avoid Mortgage Insurance
If you’re getting a conventional loan backed by Fannie Mae or Freddie Mac with less than a 20% down payment, you’ll have to pay for mortgage insurance.
Briefly, mortgage insurance is something that protects the lender and/or mortgage investor in the event that you end up defaulting on your loan for nonpayment or any other reason. It helps mitigate the increased risk a lender takes by giving you a loan with a lower down payment.
Conventional mortgage insurance comes in two forms: borrower-paid and lender-paid mortgage insurance (BPMI and LPMI).
BPMI is fairly straightforward. It’s a monthly fee that’s added to your mortgage payment. Once you reach 20% equity, you can request that this be removed if you’re current on your loan. An appraisal will be done to make sure that your house has retained at least its original value. If you don’t have an appraisal done, BPMI automatically comes off once you reach 22% equity based on the original amortization schedule. This means that you can’t get there early by paying extra toward the principal. If you have the appraisal done, you can pay down the principal to get to 20% in many cases.
There are other ways BPMI can be removed. This post has more information on mortgage insurance removal.
LPMI involves a lender paying for your mortgage insurance policy up front. Some people like this because they avoid a monthly fee for mortgage insurance. In exchange, they pay for a slightly higher rate than they would get without LPMI. A variation of LPMI is something called single-pay mortgage insurance. In this case, a client can choose to pay for some or all of their LPMI policy at closing in order to get a rate comparable to or only slightly higher than what they would get without LPMI.
It’s important to note that because private mortgage insurance (PMI) rates are based on the size of your down payment, mortgage insurance rates on a conventional loan can be lower with a higher down payment. Quicken Loans also has some of the best PMI rates available.1
FHA loans have mortgage insurance premiums (MIP). These rates are set by the federal government and vary with the size of your down payment. But, for example, if you make the minimum down payment, your annual premium paid in monthly installments would be equal to 0.85% of your loan amount. All FHA loans also have an upfront mortgage insurance premium of 1.75% of the loan amount. This can be built into the loan to cut down on closing costs.
If you make a down payment of 10% or more, you’ll pay MIP for 11 years. Otherwise, it’s for the life of the loan.
USDA loans have upfront and annual guarantee fees that function like mortgage insurance but have lower premiums than FHA loans. No matter your down payment, they stick around for the life of the loan, but the upfront premium may be built into the loan amount.
VA loans have no mortgage insurance, but instead have a funding fee that must be paid, unless you’re a disabled veteran or surviving spouse. The amount of the funding fees varies based on how many times you’ve used a VA loan and the size of your down payment, if any. In most cases, this upfront funding fee can also be built into the loan.
Lower Rate
All other things equal, the higher your down payment, the better rate you’ll get from your lender.
The reasoning for this is simple: A higher rate equates to less risk for the lender and mortgage investor. Not only do they have to lend less money, but they also know that if you have a significant investment in the home, you’re going to do everything you can to keep it before letting it go if you get in financial trouble. With lender pricing, even a down payment of 8% or 10% could make a significant difference compared to the minimum.
What Is Considered a Good Down Payment?
Knowing what you know now, what’s the right down payment for you? In general, it’s as much as you can afford without compromising your financial stability or future financial goals.
If you think about it, that’s not a very definitive answer. I realize that, but so much depends on your situation and your particular household. We’ve just gone over the advantages of a higher down payment, but when you buy a house there are also other things to consider.
If you’re buying your first house, there’s a very good chance you may need things like furniture, dishes and appliances. Who doesn’t love shopping for window treatments?
You also have to consider setting aside between 1% – 2% of your home’s value for maintenance. There may be years where nothing breaks, and then there will come a time when you have to replace both the refrigerator and the air conditioner within months of each other.
You might also be saving for a college fund or retirement fund down the line. Or maybe you’re paying for a car. All of these could be good reasons to make a lower down payment with an eye toward the future.
Hopefully this article has given you a better idea of what to think about when it comes to saving for a down payment. If you’re ready to move forward, you can apply online or give one of our Home Loan Experts a call at (800) 785-4788. If you have any questions, you can leave them for us in the comments below.
This post has some ideas on what you can do to boost your down payment savings strategy.
1BPMI monthly and LPMI single rate data is compared to publicly published private mortgage insurance rates.
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