Down Payment: What Is It And How Does It Work?

If you’re ready to put renting behind you and buy a house, a great first step is to save for a down payment.

Use our quick guide 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.

A down payment on a house is the money a buyer pays upfront to complete the real estate transaction. Down payments are typically a percentage of a home’s purchase price and can range from 3% – 20% for a primary residence.

The required down payment is usually determined by the type of mortgage you choose, your financial situation and the type of property you’re buying (a primary residence or an investment property, for example).

The amount you put toward a down payment can dictate the loan amount you qualify for and the terms of your mortgage repayment. Putting money down on a house also helps lower your total loan amount. The less money you borrow, the more money you save on interest over the life of the loan.

A larger down payment may help you purchase a higher-priced home or get a lower interest rate. However, there are reasons to put down less on a house. Let’s look at how your down payment can affect the terms of your loan.

Down Payment Example

Let’s say you want to purchase a $300,000 home and make a 10% down payment ($30,000) on a 30-year mortgage. The remaining balance you would need to finance with a home loan is $270,000. With a 30-year fixed-rate mortgage at 7% interest, your monthly mortgage payment would be about $1,796 – excluding taxes or insurance costs.

Now, let’s say you put down 20% on the $300,000 home, which is $60,000. With a 20% down payment, your total loan amount would lower to $240,000. Using the same 7% interest rate, your monthly mortgage payment would be around $1,596 – excluding taxes or insurance costs.

Though you pay more upfront in the second example, your monthly mortgage payments will cost about $200 less. That may not seem like much, but it doesn’t paint the entire picture. Making a 20% down payment to buy a house can also save you hundreds of dollars a month because you won’t pay mortgage insurance, your lender may offer a lowerinterest rate and you’ll pay interest on a lower total loan amount. In our second example, with a 20% down payment, you would pay interest on a $240,000 loan rather than the $270,000 loan in our first example.   

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.

There are several benefits to putting down a 20% down payment. Let’s explore why a 20% down payment or higher can help you in the long run.

Lower Rates And Premiums

Lenders appreciate large down payments because it lowers their financial risk and shows that you’re a motivated buyer. The larger your down payment, the less you pay each month in principal and interest. Think of a down payment as an interest-free way to get a jump-start on paying off your home.

Avoid Mortgage Insurance

You generally need to put 20% down to avoid paying private mortgage insurance (PMI) on a conventional loan. PMI istypically a monthly fee that gets added to your monthly mortgage payment or is paid upfront by the lender in exchange for a slightly higher interest rate.

On a Federal Housing Administration (FHA) loan, 10% down can be the difference between paying mortgage insurance for the life of your loan or for the first 11 years.

Lower Debt-To-Income Ratio (DTI)

A lower DTI can mean more borrowing power. DTI represents how much of your monthly income is used to pay off debt, and most mortgage lenders require a DTI around 43% or lower. A high DTI can hurt your chances of getting approved for loans or new credit. If you want to apply for other loans or buy a second home, borrowing less by putting more down can help keep your DTI ratio manageable.

Saving for a down payment on a $431,000 home (the national median home sales price) is challenging – let alone saving 20%. According to a 2022 National Association of REALTORS^® survey, first-time home buyers typically put 6% down on their homes. And about 22% of surveyed buyers reported getting the money from a family member or friend.

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

Buy Sooner

It can take years or even decades to save up for a 20% down payment. A lower down payment can help you own a home sooner.

Money For Repairs And Renovations

Emptying out your savings 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 originally budgeted for. Setting aside cash reserves upfront can make homeownership less stressful.

Keep An Emergency Fund

Keeping some money in the bank for emergencies, rather than spending it all on a down payment, can be a smart move. You won’t have to pay for unexpected car repairs or medical bills on credit and rack up high-interest debt. Hanging on to some money can offer peace of mind and is a cheaper way to cover emergency expenses.

Money For Other Ventures

Factor in the opportunity cost when considering 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.

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

A Down Payment Can Lower A Lender’s Risk

Here are some ways putting money down can help a lender feel more confident about a borrower’s ability to repay their home loan:

• It represents your investment in the home. If you stop making mortgage payments, you’ll be walking away from the thousands of dollars you 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 has to lend you 80% of the purchase price. That’s less money they’ll be entrusting you to repay.

It’s important to note that down payment requirements aren’t solely determined by lenders. In many cases, the down payment requirement is set by the entity backing the loan, which may be the FHA, Fannie Mae or the Department of Veterans Affairs (VA).

Let’s look at some common questions about down payments.

Does your down payment affect your interest rate?

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

A lower interest rate can help you save money by paying less interest over the life of the loan. If you put down less money upfront, you may end up with a higher interest rate.

Does your down payment affect your monthly mortgage payments?

A larger down payment usually means smaller monthly mortgage payments. Since your loan balance is smaller, your monthly mortgage payments are smaller.

What is the minimum mortgage down payment?

You may have heard you need to make a 20% down payment to buy a home. But, for many buyers, a 20% down payment can be unrealistic. Fortunately, 20% down isn’t a requirement for a primary residence. The average down payment on a home is about 6%.

Over the years, the industry has changed to make homeownership more accessible. Today, you can get a mortgage for as little as 3% down. And some loans, like VA loans and U.S. Department of Agriculture (USDA) loans, require no money down.

What down payment assistance programs are there?

Saving for a down payment is a common homeownership hurdle to clear. But depending on your location and level of financial need, you may have 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.

A down payment is a crucial part of your home loan, but it’s only a small piece of your overall financial picture. Knowing the down payment amount you’re comfortable with can help you search for homes in your budget and keep you from draining your savings.

If you’re ready to finance your home buying dreams, apply with Rocket Mortgage^® now.