Did you know that nearly 40 million people living in the United States move each year? After years of renting, many people may find that it is time to invest in their own property. This means a mortgage, a monthly bill, and a down payment. The down payment can be the most intimidating part of the real estate buying process for some people. But, we’re here to simplify it. Keep reading for everything you need to know about the average down payment on a home.
Why Do You Need to Put a Down Payment on a Home?
The down payment acts as a security blanket for the person giving you a home loan. The amount of the purchase that you pay in cash can tell the lender that you have the financial stability to make a large purchase.
We express down payments in percentages to make it easier to determine how much of the home you were able to buy without financial assistance.
The majority of home loan programs have down payment requirements depending on the price of the home you’re buying.
Related Article: Best Ways to Save for a Home Down Payment
What Are the Down Payment Requirements When Buying a New Home?
If you’ve ever had formal financial teaching, it’s likely that you’ve heard about the 20% rule. This down payment rule states that each home buyer should put down at least 20% of the home’s value before taking out a mortgage on the rest. However, this 20% isn’t the hard and fast law. It’s a suggestion.
Pros of a 20% Down Payment
Experts coined the 20% rule because of the benefits that come with putting down this amount.
First, you’ll avoid private mortgage insurance (PMI). This is insurance that protects the lender in the case that you default on your mortgage loan. If you pay less than 20% from the beginning, your lender should remove the PMI payments once you reach greater than 20% equity in your home (this amount can vary by loan type).
Second, you may get better mortgage interest rates if you decide to put 20% down. With the lower interest rate, you’ll have lower payments to make towards your mortgage each month.
Lastly, your 20% down payment offer may give you a competitive edge over other buyers because your loan and offer is seen as more “solid”. Lenders are more likely to approve you if you have a higher down payment, and sellers are more likely to accept your offer because you already have secure financing in place.
Cons of a 20% Down Payment
No matter how great a 20% down payment is, there are a few cons to consider.
First, a greater down payment puts you at a higher financial risk. If you put all of that money towards the house, you may not have enough left over to handle emergencies in the future. If you don’t have a lot of money left over after 20%, it may be worth it to keep some of the cash in your bank account.
Second, you’ll have less cash for any repairs or upgrades you want to make to the house or other items.
Lastly, saving up 20% may take a long time. Depending on your income and current expenses, you may take years to get to the ‘perfect’ 20% down payment.
During that time, you may be wasting your money on renting, too. In the long run, waiting longer trying to save up to 20% may be to be more costly than buying now at today’s interest rates with a lower down payment. Factoring in, home price appreciation and general inflation going with a good loan option and lower down payment may be better for you in general.
Other Down Payment Types
You don’t have to put 20% down.
In fact, less than half of home buyers follow this rule. Depending on your situation, it may be cheaper to put fewer than 20% down.
The minimum down payment requirements are going to be different for each kind of loan:
- Conventional loans: depends on the lender but likely falls between 3% and 5% for those with credit scores above 620
- FHA Loan: at least 3.5% with a credit score of 580 and higher. (See lender for details)
- VA Loan: no minimum down payment but does have other requirements
- USDA Loan: no minimum down payment but does have location requirements
To determine your minimum down payment, you’ll need to do some research on the lenders you’re considering.
Comparing Home Prices with Different Down Payments
To make your final decision about the amount you’re going to put down, you need to run some calculations. You can use a mortgage payment calculator to determine how much your down payment will affect your monthly payments.
Then, compare these findings with your current living situation. For example, consider how much you spend on rent in a year and compare it to how much you would spend on mortgage payments. You may find that paying a lower down payment now is cheaper than continuing to pay rent.
Let’s run through an example. Let’s compare paying 10% on a $200,000 home to paying 20% on the same home.
With a 10% down payment, you’ll be taking out a loan of $180,000. With average interest, you’d be paying $1,071.33 per month.
With a 20% down payment, you’ll be taking out a loan of $160,000. With the same terms, you’d be paying $984.29.
That’s a difference of $87.04.
You have to decide whether $87 per month is worth waiting to save for a larger down payment.
Paying for Homes Without a Down Payment
Many people wonder if they can buy a home without a down payment. Fortunately, you can. However, this may not be the best choice.
If you choose to skip the down payment altogether, you’ll likely take yourself out of the market for commercial loans. Instead, you’d need to get a government-backed loan.
Lenders who offer government-backed loans are looser with the terms. This is because the government will make necessary payments if you end up defaulting on the loan.
Some government-backed loans have very low minimum down payments while some have no minimum at all, meaning that you could pay 0% down.
If you qualify, VA and USDA loans have a no down payment guarantee.
Ways to Start Saving for Down Payments
If you’re worried that you don’t have enough for a down payment, you may need to start setting some money aside. You may save up over time, take money from a previous home sale, sell investments, or get help from friends and family.
If you don’t have a lot of wiggle room in your budget, you should consider talking to lenders about the amount you have saved up now. You may have enough to make a sufficient down payment, even if it’s not 20%.
First-Time Home Buyers
If you’re selling a current home and moving into a new one, the down payment is likely going to be easier for you. Many home buyers use a previous house sale to pay for their upcoming house purchase.
For first-time home buyers, the down payment is a little more complicated. They don’t have a previous asset to help them get their next one.
Luckily, there are many programs out there to help first-time home buyers. These programs set the down payment requirements lower. And, many of them don’t affect the interest rate or monthly payment that the buyer needs to make.
This means that you’ll be paying less for your mortgage overall.
Down Payment Gift Rule
Many first-time homebuyers opt to take advantage of down payment gift rules. This allows you to use gifted money for part of all of your down payment.
If you choose to go with this option, you’ll need to abide by some pre-determined rules and regulations.
First, you need to tell your lender who’s sourcing the money. Is it one of your parents, a sibling, a grandparent, or someone else?
Your lender may need to check 3+ months of your bank statements so that they can track any large deposits from the person sending the gift.
Additionally, your lender is going to make sure that the gift is – in fact – a gift. If you’re expected to pay back that money, it’s a loan rather than a gift.
Next, your lender may ask for a letter from the person loaning you the money clarifying your relationship and defining the details of the gift, including the amount and source. This letter should also explicitly state that the gift is a gift rather than a loan.
Lastly, your lender will consider the requirements of the kind of mortgage loan you want. Some loans only allow a certain percentage of the down payment to be a gift.
Put a Down Payment on a Home Today
20% isn’t a hard and fast rule. When it comes to putting a down payment on a home, you need to consider your current circumstances and compare those with your potential circumstances as a homeowner.
Putting down a small payment now may be better than waiting.
If you’re ready to shop for homes now, we are here to answer your questions!