What is a down payment and how does it work?

One of the first steps on your home-buying journey is saving up for a down payment. A down payment is an upfront lump sum that a buyer pays toward the purchase price of a home, which is separate from closing costs. It’s typically expressed as a percentage of the total cost of the home, with the remainder covered by a mortgage. The average down payment may vary by state and the purchase price of the house.

A down payment lowers the overall loan amount, which can lead to better loan terms and potentially lower interest rates for the borrower. The amount you pay is generally a percentage of the total purchase price, typically ranging from 3% – 20%, depending on the type of loan and your borrower profile.

Use our guide below to understand what a down payment is, why you usually need to save for one, and how much you should put down to buy a home.

Why do lenders require a down payment?

When your mortgage lender gives you a loan, they’re investing in you, and all investments come with some degree of risk. A lender’s risk is that the borrower may stop making mortgage payments, and they won’t recover the money they loaned.

Here are some ways putting money down can help a lender feel more confident about your ability to repay the home loan:

• The required down payment represents your investment in the home. If you stop making mortgage payments, you’ll be walking away from the thousands of dollars you already invested in the property with your down payment.
• It lowers the mortgage loan amount. If you make a down payment that’s 20% of the home’s purchase price, the lender only needs to lend you 80% of the purchase price.
• Buyers who struggle to save enough for a down payment may qualify for down payment assistance, depending on their unique situation and the qualifications.

In many cases, the down payment requirement is set by the entity backing the loan, which may be the Federal Housing Administration (FHA), Fannie Mae, Freddie Mac, or the Department of Veterans Affairs (VA).

Minimum mortgage down payment requirements

The amount you need for a down payment usually depends on what type of mortgage you’re getting. The traditional expectation of a 20% down payment is often associated with avoiding private mortgage insurance (PMI) on conventional loans, but buyers can and often do put down less.

Over the years, the industry has evolved to make homeownership more accessible. Today, you can get a mortgage for as little as 3% down, if you meet other requirements of the loan type.

Here are the minimum down payment requirements by loan type:

Use a mortgage calculator to see how your monthly mortgage payment can be affected by the size of your down payment. You'll enter some basic information to get an estimated monthly payment, and you can adjust down payment amounts to see what may work best for you.

Although a 20% down payment is not mandatory, making such a substantial up-front payment can lead to smaller monthly mortgage payments and potentially better interest rates.

Depending on your location and level of financial need, you may have loan programs and down payment assistance options to explore. Some programs are only available to first-time home buyers, while others require a minimum credit score. Be sure to check the requirements for any programs you’re interested in.

Benefits of a larger down payment 

Here are some of the benefits to putting down a 20% or higher down payment that can help you in the long run:

Lower interest rates 

The size of your down payment can have a direct impact on the interest rate your mortgage lender sets. The larger the down payment, the lower your interest rate may be.

As we’ve discussed, lenders appreciate large down payments because it lowers their financial risk and shows that you’re a responsible, motivated buyer. The lower interest rate you may get with a larger down payment can help you save money by paying less interest over the life of the loan.

Smaller monthly payments

A larger down payment typically results in smaller monthly mortgage payments because it reduces the overall loan balance. Additionally, securing a lower interest rate can further decrease monthly costs.

With lower mortgage payments, you have more flexibility to allocate your income toward other expenses or investments. Making a down payment of at least 20% of the home’s value also eliminates the need for private mortgage insurance (PMI), further reducing your monthly payments.

Avoiding private mortgage insurance

You generally need to put 20% down to avoid PMI on a conventional loan. PMI is typically a monthly fee that is added to your mortgage payment or paid upfront by the lender in exchange for a higher interest rate.

Putting at least 10% down for FHA loans can significantly reduce costs, as it limits the mortgage insurance premium (MIP) to the first 11 years instead of the entire loan term.

Instant equity in your home

Since your home’s equity is the difference between your home’s value and your remaining mortgage balance, a larger down payment can instantly give you 20% equity. As your equity grows, you access it for projects or unexpected expenses through a home equity loan or cash-out refinance.

Reasons to make a smaller down payment

According to a 2024 National Association of REALTORS^® survey, first-time home buyers typically put 9% down on their homes.

Let’s explore some scenarios where it may make financial sense to make a smaller down payment.

Buy a home sooner

It can take years to save for a house or even a 20% down payment. A lower down payment can help you own a home sooner. Depending on the current housing market, it could be more beneficial to look into buying sooner rather than later.

Save money for repairs, renovations, or other expenses

Emptying out your savings account for your down payment may not be the best financial decision in the long run. You may need more money for repairs and renovations than you initially budgeted for. You may also want to have funds available to pay for moving costs, utilities, appliances, and household decor.

Setting aside cash reserves, or creating an emergency fund, can make homeownership less stressful.

Afford closing costs

Your down payment is a separate expense from your mortgage’s closing costs. Average closing costs can equal 3% – 6% of your whole loan amount and are due at closing. If making a larger down payment means you’d struggle to afford these costs, then you’d be better off putting down a smaller percentage upfront.

Set aside money for other investments

Factor in the opportunity cost before putting down more money upfront. Though a larger down payment may earn you a lower interest rate and monthly mortgage payment, it may make more sense to use the money for college tuition, investments, or retirement.

The bottom line: Decide what size down payment works for you

While it’s easy to assume you must have a 20% down payment, there are now many types of loans that allow borrowers to put much less down. This is good news for buyers who want to start building equity and to enjoy other benefits of owning a home. As you look at your finances, it may become clear how much you can reasonably save over time for your down payment.

Once you’ve decided on the down payment amount, you’re comfortable with, this can help you stay within budget and not drain your savings. While the required down payment will vary by loan type, it’s also important to weigh what else you could put some of that money toward. Both large and small down payments have their advantages, so think about your long-term homeownership goals before deciding what’s right for you.

If you’re ready to finance your home buying dreams, get started today with Rocket Mortgage^®.