The down payment is one of the largest up-front costs when purchasing a property. Not to be confused with closing charges, the down payment is the upfront portion of the purchase price. If you put less money down on a property at closing, you will typically pay more in fees and interest over the life of the loan (and vice versa).
Table of Contents
Your down payment has a significant impact on your loan-to-value ratio (LTV). To obtain the LTV ratio, the loan amount is divided by the property's estimated fair market value, as determined by an appraisal. The more your down payment, the less your LTV will be (and vice versa). Since lenders use LTV to evaluate borrower risk and price mortgages, a lower LTV implies you pay cheaper mortgage interest rates and may avoid additional fees.
A lower LTV ratio exposes lenders to less risk. Why? You have more equity in your home to begin with, which indicates that you have a larger investment in your property relative to the outstanding loan balance. Lenders estimate you will have a lower likelihood of mortgage default. If you default on your mortgage and the lender must foreclose, they are more likely to resell the property and recover the majority of the loan value if the LTV ratio is lower.
Lenders utilize the LTV ratio to price your mortgage, in addition to evaluating your risk. A lower LTV ratio will usually result in a lower interest rate. Expect higher loan rates if the LTV ratio reaches 80%, implying you've placed less than 20% of the home's value down. These rates reflect the additional risk associated with lending you money.
In addition, if your LTV ratio surpasses 80%, you will likely be required to pay for private mortgage insurance (PMI). The amount of PMI you must pay depends on the type of loan you have. Some FHA-insured loans, for example, demand both an upfront mortgage insurance payment paid at closing and an annual mortgage insurance premium (MIP) for the life of the loan. Although FHA loans need a low 3.5% down payment, the total cost of borrowing, as estimated by the annual percentage rate, is typically substantially higher for these loans.
Historically, homebuyers needed a 20% down payment to purchase a property. The times have evolved. Many homebuyers, especially first-time homeowners, lack the 20% down payment required by most lenders. As home prices climb in a number of U.S. housing markets, this is increasingly the case. According to the most recent data from the National Association of Realtors, the median price of an existing home in October 2021 was $353,900, an increase of 13.1% from October 2020s, $313,000.
According to the NAR's 2021 Home Buyers and Sellers Generational Trends Report, purchasers who financed their purchase paid down an average of 12% of the purchase price.
Several types of mortgages offer a low down payment alternative for consumers who cannot afford a 20% down payment.
It can be difficult to save enough money for a home's down payment. Here are a few tips to help you get there:
The logistics of making a down payment are rather simple. Imagine that you have an accepted offer to purchase a property for $500,000 with a 20% down payment. The amount of the down payment would be $100,000 = (500,000 x 0.20). This amount must be deposited promptly into an escrow account, which will be maintained until closing. It will be applied toward the total amount owed at closing.
You should read our article to determine the income that you need in order to buy a house.