If you’re getting ready to buy a home, you have much to consider. One of the most important factors in the home buying process will be your down payment. Many home buyers aren’t able to purchase a home with cash outright, and instead need to get a loan from the bank. Part of the lending process is deciding how much you’re able to put forward for a down payment.
Whether you’re a first-time home buyer or are moving from your current home to a new one, a down payment will be a key part of the process. This is because your down payment will determine how much you pay for the house, both for your monthly mortgage and over the life of the loan. In this article, we’ll walk through what you need to know about down payments so you can buy your dream home with confidence.
Do you need a down payment to buy a house?
Buying a house with no down payment usually requires you to pay in cash for the house in full. Otherwise, you’ll need a mortgage to purchase your home. There are several ways to apply for and get a mortgage, from your local bank to companies that exclusively exist to offer home loans. Most conventional mortgages require some form of down payment.
There are a few loans, such as VA loans and USDA loans, that are guaranteed by the government and have no down payment requirement.
VA loans are guaranteed by the U.S. Department of Veterans Affairs. These home mortgages help current or veteran military service members purchase homes. Surviving spouses are also eligible.
While VA loans are offered by private lenders, the VA guarantees some portion of the loan. This lets the lender provide you with favorable terms, such as lower interest rates, limited closing costs, and no PMI required.
USDA loans for rural and suburban home buyers are backed by the U.S Department of Agriculture as part of its Rural Development Program. These loans are subject to income limits and include other requirements. The USDA loan program could be a good option if you meet its guidelines. Much like VA loans, this option offers fixed-rate loans through private lenders and requires no down payment.
How much is a down payment for a house?
While advice used to be that your down payment should be at least 20% of the home price, that is no longer the standard. Your down payment will depend on many factors, including your credit score, loan type and the price of the home you’re buying. Some loan types, like conventional loans, allow you to put a minimum down payment of 3%. According to the National Association of Realtors, the average down payment for first-time home buyers has ranged between 6-7% since 2018.
Your down payment amount counts as your initial investment in your home. A mortgage lender is more likely to give you a lower interest rate on your loan if you make a larger down payment. Down payments that are lower than 20% usually require you to pay for private mortgage insurance (PMI). If you’re not eligible for a USDA loan or VA loan, you may qualify for an FHA loan backed by the Federal Housing Administration or other house down payment assistance programs.
However, remember that mortgage lender requirements for a down payment depend largely upon the loan provider and your credit score. The better your credit, the lower your down payment requirement will be. This is because the bank sees you as a lower risk to lend to, similar to how you can get better premiums on your homeowners insurance if the carrier sees you as less risky to insure.
What is a loan-to-value ratio?
Your down payment also helps determine another factor in your credit application: the loan-to-value ratio of your mortgage. Loan-to-value ratio (LTV) helps lenders determine your eligibility for credit. It shows the lender how much you’ll owe on your home after your down payment. The LTV is commonly expressed as a percentage (ratio) between unpaid principal and the home’s appraised value. Higher down payments lead to smaller loans—and lower LTV with it.
Banks use the following formula to determine loan-to-value ratio:
Amount of loan ÷ appraised value or purchase price = loan-to-value (LTV)
When considering whether to use the appraisal value or purchase price, lenders will use the lower amount. Here’s an example:
- Your proposed home purchase is appraised at $178,000, but you purchase it for $180,000.
- The bank bases the loan amount on the $178,000, as that’s the lower amount.
- You saved $28,480, which is 18% of your home’s purchase price. You’ll need to borrow $149,520 to meet the full purchase price.
- The LTV equation would be $149,520 ÷ $178,000 = 84%
Loan-to-value ratio isn’t the only thing that determines whether you are approved or not. It also takes into account your credit score and debt-to-income ratio.
What You Should Know About Your House’s Down Payment
If you’re worried about having enough funds for a down payment, remember that while 20% is an optimal amount, it’s certainly not a requirement. The typical down payment for a house is about 6%. If you think home ownership is on the horizon, you can prepare to save for a down payment by keeping the following in mind:
- Know your budget: Having a set budget in mind can help you determine the maximum amount of house you can afford.
- Calculate your debt-to-income ratio: Your housing expenses should be no more than a third of your monthly income.
- Calculate your goal: Whatever amount you decide to save for, set a clear goal and timeline.
- Minimize current expenses: Cut out unnecessary expenses, such as extra streaming services or dining out. This includes avoiding impulse purchases.
- Set automatic transfers and deposits: The best way to save money is to do it without thinking about it. Automatic transfers and deposits put away your money without you having to do anything.
When is private mortgage insurance (PMI) required?
When your down payment is less than 20%, your loan-to-value ratio exceeds 80%. Lenders commonly require homebuyers in this situation to pay for private mortgage insurance, or PMI. Private mortgage insurance covers losses for the bank in the event that your loan goes into default.
If you’re able to wait to buy a home, saving money for your down payment can help you avoid paying PMI each month. Alternately, you can pay enough of your loan balance off that PMI will no longer be required. It ultimately depends on your situation and level of comfort.
SelectQuote Can Help You Protect Your New Home with Homeowners Insurance
Part of purchasing a home is making sure you have homeowners insurance to protect it. While shopping for the right coverage may seem intimidating, it doesn’t have to be when you work with SelectQuote. Our licensed insurance agents do the shopping on your behalf, searching and comparing plans from different trusted carriers in just minutes. We’ll find the right policy for your needs and budget so you can focus on enjoying your new home.