If you’re in the market to buy a new home or condo, you’ve undoubtedly thought (or stressed) about the down payment. It’s typically one of the biggest roadblocks to homeownership.
But how much should you put down? Better yet, how much do you need to put down? Well, let’s talk about that.
How Mortgage Down Payments Used to Work
- It started with 20% down or more
- Then quickly went to zero down as home prices became too expensive
- Then the crisis hit and low down payments were to blame
- Now we’re back to a relatively low 3% to 3.5% down
Back before the mortgage crisis unfolded, perhaps in the late 1990s and early 2000s, it was quite common for homeowners to come up with at least 20% of the sales price for down payment. This was the traditional number banks deemed acceptable in terms of risk.
So prospective homeowners took their time, saved up money in the bank, and when the time was right, made a bid on a property.
The way the banks saw it, borrowers had “skin in the game,” and were therefore a pretty safe bet when it came to making timely mortgage payments.
Even if they did fall behind, those down payments would ensure the bank wouldn’t be stuck holding a property that was worth less than the mortgage. And there would be enough of a buffer to offload it without much if any loss.
Then Things Got Risky…
- Allowing home buyers to get a mortgage with zero down
- Is a risky endeavor
- Especially if home prices are expensive and ripe for a fall
- That’s why we saw so many underwater borrowers during the crisis
But before long, mortgage lenders got more and more aggressive, allowing homeowners to come in with little or even nothing down. In fact, closing costs could be piled on top of the loan, so you could get a mortgage with absolutely no out-of-pocket expenses.
You may recall the radio commercials about no cost refis, which were deemed the biggest no-brainer of all time!
Anyway, this was all predicated on the idea that home prices would appreciate up and up, forever and ever. So even if you didn’t have much of a down payment to start, you could bank on some fairly instant home equity via guaranteed appreciation.
Of course, we all know how that turned out, and that’s why many of these types of loan programs are no longer available. This is probably a good thing.
Sure, there are still some programs kicking around that allow you to come in with nothing down, but there are a lot of eligibility requirements and income restrictions.
What Is the Minimum Down Payment on a House?
The most widely used zero down mortgage program currently available is offered by the USDA. It’s a low-income, rural home loan program, meaning it’s only available to those who live outside major metropolitan areas.
There are also zero down VA loans available to veterans, but once again, this is only an option for a fraction of the population.
Nowadays, for the vast majority of borrowers who didn’t serve this country or purchase a home in a rural area, a down payment will be required, though not necessarily a large one.
If you’re looking to put very little down, the next closest thing to zero down is a Fannie Mae Homepath mortgage.
The program allows borrowers to come in with as little as 3% down when purchasing a Fannie Mae-owned property, otherwise known as a foreclosed property. And the down payment can be a gift, grant, or a loan from a non-profit organization or an employer.
The beauty of this program is that despite there being such a small down payment requirement, no mortgage insurance is required. But again, this program is only available on a small portion of the homes out there.
Update: Fannie Mae and Freddie Mac are now allowing purchases and refis as high as 97% LTV for those looking to put down just three percent. And the properties don’t need to be owned by Fannie or Freddie.
Mortgage Insurance Often Required If Little Is Put Down
- If you put less than 20% down
- Or go with a government loan such as FHA
- You will have to pay mortgage insurance
- Which is one of the disadvantages of a low down payment
For most loan programs, mortgage insurance will be required by the lender if your loan-to-value ratio (LTV) exceeds 80%. In other words, if you put down less than 20%, you’ll be stuck paying insurance to compensate for the increased risk to the lender.
This is on top of homeowners insurance, so don’t get the two confused. You pay both! And the mortgage insurance protects the lender, not you in any way.
Obviously, this extra fee will increase your monthly housing expense, making it less attractive than coming in with a 20% down payment. But for many would-be home buyers, a 20% down payment just isn’t a reality, especially with home prices on the rise.
If you opt for an FHA loan, which allows down payments as low as 3.5%, you’ll be stuck paying an upfront mortgage insurance premium and an annual insurance premium. And annual premiums are typically imposed for the life of the loan. This explains why many opt for a FHA-to-conventional refi once their home appreciates enough to ditch the MI.
And if you take out a conventional home loan with less than 20% down, you’ll also be required to pay private mortgage insurance in most cases. This is less than ideal if you’re trying to keep your costs down, but a decent option for those with little in the bank.
If you don’t want to pay it separately, you can build the PMI into your interest rate via lender-paid mortgage insurance, which might be cheaper than paying the premium separately every month. Just be sure to weigh both options.
Mortgage Rates Are Higher on Low Down Payment Loans
- If you put little down
- Expect a higher mortgage rate
- All else being equal
- To account for elevated risk
Regardless of what you wind up paying in mortgage insurance premiums, know that your mortgage rate will likely be higher if you come in with less than 20% down.
Again, we’re talking about more risk for the lender, and less of your own money invested, so you must pay for that convenience.
Generally speaking, the less you put down, the higher your interest rate will be thanks to costlier mortgage pricing adjustments, all other things being equal. And a larger loan amount will also equate to a higher monthly mortgage payment.
This can make qualifying more difficult if you’re close to the cutoff, so you should certainly compare different loan amounts and both FHA and conventional options to determine which works out best for your unique situation.
A Smaller Mortgage Down Payment Can Leave a Helpful Cushion
- You don’t necessarily need a large down payment
- Especially if it will leave you with little in your bank account
- Sometimes having money left over for an emergency
- Is a better position while you build your asset reserves
While a larger mortgage down payment can save you money, a smaller one can ensure that you have money left over in the case of an emergency, or simply to furnish your home!
Most folks who buy homes make at least minor renovations before or right after they move in. They also spend money on moving trucks and/or movers.
If you spend all your available funds on your down payment, you might be living paycheck to paycheck for some time before you get ahead again.
In other words, make sure you have some money set aside after everything is said and done. The lender will probably require that you have some cash reserves in order to close your mortgage, but even if they don’t, it’s wise to make it a requirement for yourself.
Tip: Consider a combo loan, which breaks your mortgage up into two loans. Keeping the first mortgage at 80% LTV will allow you to avoid mortgage insurance and keep your interest rate at bay. Or get a gift from a family member – if you bring in say 5% down, perhaps they can come up with another 15%.