If you’re in the process of deciding whether or not to buy a home, one of the things you need to carefully consider is your down payment. Most first-time home buyers aren’t able to purchase their first home outright with cash. You’ll likely require a loan from a bank to make your purchase. Part of that process is making a down payment.
Whether you’re purchasing your first home or are moving to a new one, the question of down payments can have a big impact on your home purchase. Let’s look at some of the major ways the down payment process changes how much you’ll pay for your home, both each month and over the life of the loan.
Do you need a down payment to buy a house?
Buying a house with no down payment usually requires you to pay cash. 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?
The amount of money you put down on a home can vary based on your credit score, loan type and purchase price of your home. The old adage used to be that your down payment should be at least 20%, but that’s no longer a hard rule.
Some loans, such as conventional loans, allow you to put a minimum down payment for a house of 3%. The size of your down payment counts as your initial investment in your home. According to a report from the National Association of Realtors, the average down payment on a house is 6%.
A mortgage lender is more apt to give you a better (lower) interest rate if you make a larger down payment. In addition, 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.
As we’ve noted, however, mortgage lender requirements for a down payment depends largely upon the home loan provider and your credit score. The better your credit, the lower your down payment. Much like insurance, this is because the bank sees you as a lower risk. Your down payment also helps determine another factor in your credit application: the loan-to-value ratio of your mortgage.
What is a loan-to-value ratio?
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 20% is the preferred amount, not a requirement. The typical down payment for a house is 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 about 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, dining out or clothing. 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.
Secure Your New Home with Homeowners Insurance
Regardless of how you intend to purchase your new home, you’ll need insurance to cover it. Shopping for home insurance is one extra step to home ownership, and we’re here to make it easy.
At SelectQuote, we shop coverage and prices from several trusted insurance carriers to help find a policy at a price that works for you. Save time and money by letting our licensed insurance agents do the legwork. Learn more about the home and auto insurance options available to you today.