What is a down payment on a house, and how much should I pay?

Chances are, you can’t afford to pay for a house outright when you buy it, so you take out a home loan (known as a mortgage) to finance the transaction. On your closing day (the day you take ownership of the property), you’ll sign official loan paperwork, pay various mortgage processing fees, and make your down payment. Here, we’ll share everything you need to know about down payments, so you can feel confident knowing what to expect as you wrap up the homebuying process.

How does a down payment work?

In many cases, your mortgage lender won’t let you borrow the full cost of your new residence. That means you need to come up with a percentage of the purchase price to cover the gap, known as a down payment. Generally, you must bring a certified check in the amount of your down payment to the closing. Ultimately, the funds will go to the seller.

You can get the money you need for your down payment from various sources. Many homebuyers save for years to cover the expense. Others sell assets, dip into their retirement plans, or accept gifts from loved ones. If you plan to use money gifted to you, check with your lender to ensure funds come from an eligible donor. For example, FHA loans don’t allow cousins, nieces, or nephews to contribute to your down payment.

While most people associate the concept of a down payment with buying a home, you may also need to submit money upfront when financing other large purchases, such as a car.

How much should you put as a down payment?

You might’ve heard you must put down 20% to qualify for a home loan. However, that’s not necessarily true. Your mortgage type dictates the minimum down payment required as follows:

Loan-to-value (LTV) ratio is how much you borrow in relation to what your home is worth, expressed as a percentage. Your lender will set a maximum LTV ratio for your mortgage. For example, if you’re taking out an FHA mortgage, your maximum LTV ratio will likely be 96.5%. That means the bank will loan you enough money to cover up to 96.5% of the property’s price. You’ll then need to cover the remaining balance of 3.5% with your down payment.

Once you meet the established minimum, you can decide whether to put more down. Here’s where the 20% threshold comes in.

Often, if your LTV ratio is higher than 80% on closing day (which means you put down less than 20%), you’ll have to pay for mortgage insurance. Mortgage insurance protects your lender in the event you default on your debt. 

Once your LTV ratio drops to 80%, you can usually ask your loan servicer to stop charging you for the insurance. However, if you have an FHA mortgage, you’ll likely need to pay for coverage for the life of the loan.

Here’s how much down payment money you’ll need to come up with for a $600,000 house:

As you can see, saving for a down payment can take many years – perhaps decades. If you’re struggling to come up with the money, you may qualify for assistance. Check your state’s housing finance agency to see what programs are available to you.

Why lenders typically require a down payment

Lenders typically require a down payment for two main reasons. First, a down payment is a significant investment. Since you’ve put a large sum of money towards the home upfront, you’re more likely to be committed to maintaining the property and repaying the loan for the long haul.     

Second, by covering some of the cost in cash, you reduce the size of your mortgage. Therefore, your lender assumes less risk because it lends you less money.

According to the National Association of Realtors® (NAR), the average down payment among first-time homebuyers falls between six and seven percent.

Large down payment pros and cons

Making a large down payment has its benefits. However, doing so could also have a negative impact. Let’s break down the pros and cons.

Pros of making a large down payment

• Smaller mortgage (and monthly payment). Your down payment decreases how much you have to borrow, reducing your monthly payment.
• Lower interest rate. Your lender may reward you for lessening its risk by reducing your cost to borrow.
• Fewer added costs. If your down payment is 20% or more, you may be able to avoid paying for mortgage insurance.
• More competitive offer. Agreeing to put down a significant sum upfront shows the seller that you’re serious and increases your odds of getting approved for a mortgage, both of which can make your offer stand out in a hot market.

Cons of making a large down payment

• Delayed homeownership. Amassing thousands of dollars is a challenging feat. Saving up a large down payment could postpone your home buying dreams for years. 
• Smaller emergency fund. If you put most of your spare cash down on closing day, could you replace a faulty water heater or air conditioning unit two months later without taking on debt?
• Fewer resources to upgrade the property. Making an extra large down payment is nice, but so is buying a new couch or repainting the lime green walls in the kitchen.
• Less cash to put towards other financial goals. Taking out a smaller mortgage can feel satisfying, but are you doing so at the expense of your retirement savings account?

Remember, deciding how much money to put down is a nuanced and personal process. Your financial resources and goals should govern your decision. For instance, you may not want to make more than the minimum required down payment, if doing so would leave you strapped for cash.