What is a down payment?
In real estate, a down payment is the amount of cash you put upfront towards the purchase of a home.
Down payments vary in size and are typically expressed as a percentage.
For example, if you’re buying a home for $400,000 and bring $80,000 toward the purchase, your down payment is 20%.
Similarly, if you brought $12,000 cash to your closing, your down payment would be 3%.
The term “down payment” exists because very few people opt to pay for homes using cash.
Should You Make a 20% Down Payment?
Many financial experts will tell you that to buy a home, you’ll need to come up with a 20% down payment. And that’s not bad advice. But it’s also not a must.
First of all, you can purchase a home for as little as 3.5% down with an FHA loan, if you qualify for one. Even if you get a conventional loan, you can get still away with not putting down 20%. However, if you make a down payment that’s lower than that, you risk getting stuck with private mortgage insurance or PMI.
PMI is typically paid as a premium that’s tacked onto your existing mortgage costs. Its purpose is to protect your mortgage lender in the event you’re unable to keep up with your mortgage payments. And it can be costly, easily totaling 1% of your loan amount. On a $400,000 mortgage, you’re potentially looking at $4,000 a year in PMI costs, which is why it’s often a good idea to come up with that 20% down payment at the time of your closing.
Another benefit of putting down 20% of your home’s purchase price? You’ll build equity sooner. Equity is the percentage of your home you own outright, and the more you have, the better, since you can borrow against that equity when you need money.
Benefits of a 20% down payment
A large down payment helps you afford more houses with the same monthly income.
Say a buyer wants to spend $1,000 per month for principal, interest, and mortgage insurance (when required). Making a 20% down payment instead of a 3% raises their home buying budget by over $100,000 – all while maintaining the same monthly payment.
Here’s how much house the home buyer in this example can purchase at a 4% mortgage rate. The home price varies with the amount the buyer puts down.
|Down Payment (%)||Down Payment ($)||Monthly Payment (Principal & Interest / PMI)||Home Price You Can Afford|
|3%||$884 / $116||$154,500|
|5%||$8,780||$896 / $104||$175,500|
|10%||$91,310||$913 / $87||$193,000|
|20%||$52,370||$1,000 / $0||$261,500|
Even though bigger down payment can help you afford a larger home loan, by no means should home buyers tap their emergency funds to stretch their down payment level.
Should you strive to put down 20%?
A 20% down payment is a significant amount of money for most people. According to Opendoor’s report, 82% of Gen Xers and 93% of millennials say they’d need to save up for a down payment. For some people, it can make more sense to put down less and accept a higher interest rate and monthly payment if it means building equity in a home instead of paying rent elsewhere.
But putting down 20% or more is an important goal for those who want to spend less overall on their mortgage. “It can make the home more affordable by helping you save money over time with lower interest rates and monthly payments,” says Aziz.
So while making a 20% down payment isn’t a hard-and-fast requirement when it comes to buying a home, it’s a good idea if you can pull it off. But don’t assume that you’ll be locked out of the homebuying market just because you don’t have a lot of cash. Instead, look at your options and consider whether making a down payment of less than 20% makes sense for you.