What Mortgage Down Payment Do You Need? A First-Time Borrower’s Guide

Ask most people about the biggest obstacle to buying a home, and hands down, they’ll say it’s scraping together enough money for a down payment and closing costs. But understand a key point: This is not a separate and distinct issue from landing a mortgage.

Lenders, after all, like to see clients lay down a sizable chunk of change before they fork over a mortgage loan, because this shows you have skin in the game and lowers the odds that you’ll default on your loan. So how large a down payment do you really need in relation to the purchase price of your home? Allow us to fill you in on everything you need to know.

Why a 20% down payment is best

Most financial planners recommend that home buyers make a down payment amounting to 20% of the purchase price of the home. So, with the national median home price hovering currently around $300,000 the average 20% down payment costs a whopping $60,000. Phew! (You’ll also be on the hook for closing costs.)

Sure, that’s a lot of cash, which may explain why one survey by NerdWallet of 2,000 Americans found that we spend an average of three years shoring up our finances before buying a home. But there’s good reason to start pinching pennies early: A 20% down payment enables you to avoid paying private mortgage insurance.

What is private mortgage insurance?

If you have good credit and can put at least 10% of the home price down, you can still qualify for a conventional fixed-rate loan from a lender. The catch? You’ll need to pay private mortgage insurance (PMI) along with your monthly payments, a premium that protects the lender in case you default on the loan. PMI ranges from about 0.3% to 1.15% of your home loan. But with interest rates being as low as they are, buying now even if you need mortgage insurance can be a smart move from a long-term savings perspective.

“Mortgage insurance has gained a negative connotation, but it enables many people without much money to buy homes who wouldn’t otherwise be able to,” says Barbara Carrollo-Loeffler, director of consumer and residential lending at Provident Bank.

Another silver lining to mortgage insurance: Once you have at least 20% equity in your home, you can ask your lender to cancel your PMI. And once you have 22% equity, the lender is required to automatically cancel the PMI coverage. (One caveat: Some lenders require homeowners to get a home appraisal before they’ll remove mortgage insurance.)

Of course, purchasing a home now also means that you’ll start gaining equity in the home with every monthly payment, rather than continuing to burn money on rent. You can use realtor.com®’s Rent or Buy calculator to see how much you’ll save each month.

Don’t have 20% or even 10%? Here’s what to do

Don’t have that kind of down payment cash lying around for a home purchase? You have options, especially if you are a first-time home buyer. Depending on your credit score, debt-to-income ratio and income, you could qualify for one of over 2,200 down-payment assistance programs nationwide, which help out home buyers with low-interest loans, grants, and tax credits. While a certain portion is geared to low-income buyers, you don’t have to be down and out. Just make sure the property has a good loan-to-value ratio (LTV), which basically means the home is worth the potential mortgage.

According to Jonathan Smoke, chief economist of Realtor.com: “Most consumers do not know about these programs, and those that do assume government-sponsored assistance is more difficult to get than a conventional loan is.”

And the savings can be substantial: Home buyers who use down payment assistance programs to tackle the loan amount save an average of $17,766 over the life of their loan, according to a report by RealtyTrac. But we’re talking even bigger cash in expensive housing markets such as Los Angeles, where the average down payment assistance is a handsome $40,598.

To find down payment assistance programs, buyers can search for their state on the Department of Housing and Urban Development website or using Bank of America’s recently launched database of local programs.

Another option is a government-backed mortgage, if you qualify. Federal Housing Administration (FHA) loans let borrowers put down as little as 3.5%; if you or your spouse served in the military, you’re truly in luck: Veterans Affairs loans are available with 0% down—yes: No. Money. Down. You’ll need to meet certain income and credit requirements—FHA loans call for a minimum credit score of 500, and VA loans require a minimum score of 620—but these FHA loan programs could allow you to purchase a home with less than 20% down. (Thanks, FHA!)

The downside to small down payments

While making a small down payment versus your total loan amount may seem dreamy, keep in mind that there are some drawbacks. For one, the amount of money you’re borrowing will obviously be larger, which means you’ll have to make larger monthly mortgage payments. Making matters worse, loans with down payments under 20% typically come with higher interest rates. Therefore, you’ll need to tighten your spending more than if you were making a 20% down payment, but that’s not necessarily a bad thing if the payment enables you to clinch the keys to a home now, is it?

To get a ballpark figure of the mortgage you can afford and how your down payment affects your monthly mortgage payment, punch your salary and other numbers into a payment calculator. Then stay tuned next week to learn more about the next step: getting pre-approved for a home loan.

Article by Daniel Bortz on realtor.com