What is a Down Payment?
A down payment is the money you pay upfront when buying a home, usually expressed as a percentage of the home’s purchase price. It affects everything from your monthly mortgage payment to the interest rate you can secure.
Typically the larger the down payment, the better your financial situation will be for managing your loan. This guide breaks down how down payments work, the benefits of making a larger one, and the loan programs that can help you achieve homeownership.
Looking for a tailored loan option? Learn more about Rate’s Same Day Mortgage and let us see how we can help you find a suitable loan option for your needs today.
Down Payment Defined
A down payment is the amount of money a borrower pays upfront toward the purchase of a home. It’s typically expressed as a percentage of the home’s purchase price.
For instance, if you're buying a home for $300,000, and you make a 10% down payment, that’s $30,000. The rest of the purchase price is covered by your mortgage loan, which you pay back over time, with interest.
Why is a Down Payment Important?
The down payment serves as a signal to the lender that you're committed to the purchase and have some skin in the game.
It reduces the amount of money the lender needs to provide, which means less risk for them.
A higher down payment can result in a lower interest rate and smaller monthly mortgage payments, making it easier to manage your financial decision over the long term.
How Down Payments Vary by Loan Type
Different loan programs have different down payment requirements. FHA loans, which are backed by the Federal Housing Administration, often require a minimum down payment option of 3.5%.
Conventional loans backed by private lenders may require anywhere from 5% to 20%, depending on your credit score and financial situation.
VA loans, offered through the Department of Veterans Affairs, and USDA loans, provided by the U.S. Department of Agriculture, sometimes offer the chance to buy a home with no down payment at all.
How Do Down Payments Work on a House?
Once you've decided on the amount of your down payment, it will be applied during the closing process of your home purchase.
This upfront payment reduces the loan amount, meaning the lender will cover the remaining balance of the home’s purchase price.
How Down Payments Are Applied at Closing
At closing, your down payment is combined with other costs like closing costs and any fees associated with the loan.
The down payment amount is subtracted from the total purchase price of the home, and your mortgage loan covers the remaining balance.
The Role of Escrow in Down Payments
In most real estate transactions, the down payment is placed into an escrow account. This account is managed by a third party until all the terms of the sale are finalized.
Once everything is in order, the escrow agent releases the funds to the seller, and you officially become the homeowner.
What is the Average Down Payment on a Home?
The average down payment varies based on factors like the type of loan, the region you're buying in, and whether you’re a first-time homebuyer or a repeat buyer.
Typically, first-time homebuyers make a down payment of around 6% of the home’s purchase price, while repeat buyers often put down closer to 17%.
Average Down Payments by Region
Where you live can affect the average down payment. In higher-cost areas, down payments may be higher because home prices are higher.
For example, homes in cities like San Francisco or New York often require larger down payments compared to homes in smaller, less expensive towns.
Average Down Payments by Buyer Profile
First-time homebuyers tend to make smaller down payments than buyers who are upgrading or buying second homes. This is often because first-timers have less home equity or savings account funds to pull from.
How the Housing Market Affects Down Payments
When home prices rise, down payments naturally become larger.
That’s why during times of real estate market booms, buyers might find it challenging to save up enough for a down payment, especially in competitive markets where homes sell above their asking price.
What are the Benefits of a Large Down Payment?
Making a large down payment has several benefits that can make homeownership more affordable over time. Here are five key advantages of putting more money down upfront:
Lower Interest Rates
One of the main benefits of a large down payment is securing a lower interest rate. When you put down more money, lenders see you as less of a risk. This typically results in a lower interest rate, which can save you thousands over the life of the home loan.*
Smaller Monthly Payments
A larger down payment reduces the total loan amount you’ll need to borrow. This, in turn, lowers your monthly payments, giving you more room in your budget for other financial goals, like building equity or saving for your first home.
Faster Mortgage Payoff
If you can afford a large down payment, you'll pay off your mortgage faster. With less money to repay, you can shorten your loan term, pay less interest, and become a homeowner without a mortgage sooner.
More Negotiating Power
A large down payment gives you more leverage when negotiating the purchase price with the seller. Sellers are more likely to favor buyers with a higher down payment because it indicates financial stability.
Avoiding Private Mortgage Insurance (PMI)
When you make a down payment of at least 20%, you can avoid paying private mortgage insurance (PMI), which protects the lender if you default on your loan.
This can save you hundreds of dollars per year and lower your value ratio significantly.
Can I Get a Home Without a Down Payment?
For some borrowers, it’s possible to buy a home with no down payment at all. However, these programs are usually limited to specific groups, such as veterans or rural homebuyers.
VA Loans and Zero Down Payment
VA loans, backed by the Department of Veterans Affairs, allow eligible veterans to purchase a home with a zero down payment option.
This is one of the best loan programs for those who qualify, as it offers competitive interest rates and no down payment requirements.
Who is Eligible?
To qualify for a VA loan, you must be a veteran, active-duty service member, or an eligible surviving spouse.
You’ll need to meet specific service requirements, such as a minimum number of days of active duty, depending on when you served.
A Certificate of Eligibility (COE) from the VA is also required, proving you meet the necessary qualifications.
USDA Loans for Rural Areas
USDA loans, offered by the U.S. Department of Agriculture, allow qualified buyers in rural areas to buy homes with a 0% down payment option. This can be a great option for those who live in or are willing to move to less populated areas.
Who is Eligible?
USDA loans are available to buyers in designated rural areas who meet specific income limits.
To qualify, your household income must fall below 115% of the median income for the area. Additionally, the home you are purchasing must be located in a USDA-eligible rural area.
State and Local Down Payment Assistance Programs
Many state and local governments offer down payment assistance programs designed to help first-time homebuyers cover the cost of their down payment.
These programs, like the Chenoa Fund, typically come with certain eligibility requirements, such as income limits and home price caps.
The Potential Downsides of No-Down-Payment Loans
While no-down-payment loans sound appealing, they often come with higher interest rates and fees, which can result in a higher monthly mortgage payment over time.
Additionally, buyers may have less equity in their homes, which could make refinancing or obtaining a home equity loan more difficult later.
Why Do Lenders Require Down Payments?
Mortgage lenders require down payments to reduce their risk and ensure that borrowers have a financial stake in the property. A down payment shows your commitment and helps balance the lender's potential losses if a loan defaults.
Reduces Lender Risk
Down payments minimize the financial risk for mortgage lenders by decreasing the loan amount and ensuring the borrower has an investment in the property.
This way, if the borrower defaults, the lender is less likely to face significant losses over the life of the loan.
Ensures Borrower Commitment
By making a down payment, borrowers show that they are financially committed to the purchase. Realtors and lenders alike view this as a sign of reliability, as the borrower is investing their own money upfront before taking out the loan.
Easier to Refinance Later
A larger down payment can make it easier to refinance the loan in the future. Lenders look more favorably on borrowers with significant equity in their homes, offering better refinancing terms and rates.
Protects Against Market Fluctuations
A down payment provides a buffer in case the property value drops. Lenders require down payments to reduce their risk, especially if the real estate market experiences a downturn.
This equity helps mitigate potential losses and ensures that both borrowers and lenders are protected during market shifts, making the loan safer for both parties.
How Can I Start the Mortgage Process?
Getting pre-approved is a crucial first step in securing your dream home, and Rate's Same Day Mortgage makes it fast and simple.
With tailored loan options and an intuitive app to easily track your mortgage payments, you’ll have everything you need to stay on top of your finances.
Whether you're ready to make an offer or still weighing your options, this pre-approval gives you a competitive edge in today’s market.
*Savings, if any, vary based on the consumer’s credit profile, interest rate availability, and other factors. Contact Rate, Inc. for current rates. Restrictions apply.
Guaranteed Rate, Inc. is a private corporation organized under the laws of the State of Delaware. It has no affiliation with the US Department of Housing and Urban Development, the US Department of Veterans Affairs, the US Department of Agriculture, or any other government agency.