When buying a home, you will generally need a down payment. Learn what a down payment is and how much money you should put down for a house.
Before you can submit a down payment, you need to know, what is a down payment?
A down payment refers to the initial payment on a large loan. These loans are often used to purchase big, expensive items like a home or a car. This allows purchasers to make installment payments rather than having to pay for their house or car all at once.
When looking to buy a home or a car, you may need to save up to make an initial deposit on the mortgage or car loan. Keep reading for a down payment definition to learn how down payments work, calculate down payments, and how much you might have to put down for a house.
What is a Down Payment?
A down payment is the initial upfront payment made toward the total price of a large purchase, like a home or car. The remaining purchase balance is usually financed through a loan, like a mortgage or auto loan.
Buying a house is one of the most common financial situations when you would need to save for a down payment. However, there are other types of loans that require down payments, like car loans and boat loans. With home loans, a down payment can affect loan terms, such as your interest rate. Some buyers make larger down payments to get more favorable loan terms.
Why do some lenders require down payments, and some don’t? Submitting a large down payment to buy something like a house shows your mortgage loan lenders and the home sellers that you are serious about the purchase. The lender can also use your down payment to offset its loss if you default on your loan payments.
What are Closing Costs?
In addition to a down payment, homebuyers also have to pay closing costs. Closing costs include any additional fees related to closing or finalizing the purchase of your home.
Closing cost fees might include any of the following:
- Loan origination fee: Covers the cost of processing and funding the loan, typically between 0.5% and 1% of the loan amount.
- Mortgage insurance: Protects the lender in case you are unable to repay the loan. Usually required for loans with a down payment of less than 20% of the purchase price.
- Title insurance: Protects the homebuyer and lender if there are issues with the home title. Can sometimes be around the same price as the loan origination fee.
- Homeowner’s insurance: Protects the home and homebuyers against various home-related emergencies. Usually includes the full first year of coverage.
- Appraisal fee: Pays to have the property appraised.
- Taxes: Any taxes related to the purchase of the home.
- Record filing: Pays for filing any records related to the purchase of the home.
Closing costs may include other expenses, depending on your location and specific situation. In some cases, the seller may agree to pay some of the closing costs.
Down Payment vs Closing Costs
Now that you know what is a down payment, you might be confused by closing costs. Closing costs and down payments are not the same thing. They are both initial costs involved in buying things like a home, but they are not the same initial cost.
A down payment is an initial upfront payment made toward the total price that includes your “offer to purchase” and shows the seller and lender that you are serious about this purchase and ready to begin the loan agreement, while a closing cost includes multiple payments that go toward additional fees related to closing or finalizing the purchase.
How Do Down Payments Work?
A down payment works kind of like a security deposit on both a large purchase and the loan you need to finance the remaining balance of the purchase, except this deposit is going toward the total purchase price rather than being set aside to be refunded later.
To make a down payment, you’ll first want to save up for the down payment amount, secure financing for the remaining purchase amount, once approved you’ll pay the down payment, sign the loan agreement, and start making payments on your new loan.
1. Save up for a down payment
The first thing you’ll want to do is start budgeting and saving up for this large purchase and the down payment you’ll need for it. It can help to determine what kind of loan payments you can afford, what total loan amount you can qualify for, and what down payment amounts you can reasonably save up for.
2. Secure financing for the remaining purchase amount
Once you save up your down payment amount, you can start looking for financing to cover the remaining balance on this larger purchase. For example, if you’re shopping for a home you may shop around for a mortgage lender that can qualify you for the amount you need.
3. Pay the down payment and start the loan
After you have your down payment and financing in order, you can make your down payment and your lender will fund the remaining money needed to purchase the home. For example, if you make a 20% down payment, the lender will fund the remaining 80%. Then you’ll start making payments on what you borrowed.
How to Calculate Your Down Payment
Down payments may vary in exact amount. Most lenders will require a down payment between 3% and 20% of the purchase price of your home. To determine the amount you need for a down payment, multiply the purchase price of the home by the percentage down payment required.
For example, if you need a 20% down payment, you would use the following formula:
Home Price x 0.20 = Down Payment Amount for a House
Now, let’s say the purchase price is $400,000:
$400,000 x 0.20 = $80,000
Therefore, you would need to save $80,000 for a 20% down payment on a $400,000 home.
When determining your down payment, you may want to consider the loan-to-value (LTV) ratio, which compares your loan amount to the value of your home. The higher your down payment, the lower your LTV ratio, which translates to lower risk to the lender. To calculate your LTV ratio, you can do the following:
(Loan Amount / Home’s Appraised Value) x 100 = Loan-to-Value Ratio (LTV)
Consider calculating higher down payments during your search to see if it is feasible for your budget to lower your LTV ratio.
Down Payment Example
As of July 2024, the median home price in the United States is $438,837. Let’s see what a 20% down payment would look like for the average home prices right now:
$438,837 x 0.20 = $87,767
Therefore, you would pay a $87,767 down payment on the average home in the US right now.
What is the Average Down Payment on a House?
It's not enough to know what a down payment is — you also need to know how much down payment is required to buy a house. To know how much a down payment on a house is, you'll take a few factors into account, like the price of the home. Usually, you want to pay at least 20% of the home’s price.
If you pay less than this, then you’ll need to pay for Private Mortgage Insurance (PMI). PMIs are often required for Federal Housing Administration (FHA) loans because FHA loans only require as little as 3.5% as a down payment on a home.
However, while the goal is to reach 20% for better loan terms, the average house down payment in the United States is lower in many places. The nationwide average is about 14.4% of your home’s purchase price, with an average median down payment of $34,248.
Average Down Payments for First-Time Home Buyers
The average down payment for a first-time home buyer was 8% in 2023. While this is much lower than the average of 19% for repeat buyers, it’s also the highest percentage since 1997, when first-time home buyers were typically putting down around 9%.
First-time home buyers may be intimidated by the traditional 20% down payment, but fortunately, there are ways to avoid paying that much. For example, conventional and FHA loans typically offer funding to borrowers with down payments as little as 3%, plus down payment assistance is available to some buyers.
How to Save for a Down Payment
Once you know the answer to what a down payment is and how it works, you can start saving up. Saving for a large down payment is hard. It can take a lot of time, so it’s important to start sooner rather than later.
Make Monthly Savings Account Payments
Start by making monthly payments into your savings account. Any extra money you have at the end of each month could go into a savings account. It can also help to have an estimate of how much you need to save and when you want to have it all saved by. That way, you can plan your monthly payments accordingly.
Earn More Money
Another great way to save money for a down payment is to earn more money. Increase your income by asking for a raise, finding a new job that pays better, or starting a side hustle of some kind to earn extra money. You could also earn extra money by doing things like having a yard sale.
Spend Less Money
Spend less money so you have more money to deposit into your savings account. You might be surprised how much less money you can spend each month. Make a detailed budget to help you, or use a prepaid card to keep your spending under control.
Request Monetary Gifts
When time for gifts come around, like birthdays, holidays, or other life events, request monetary gifts instead of presents from your friends and family. This can be a great way to get extra money that can go toward your savings for a home, especially if there aren’t other gifts you really want or need right now. Just be sure to include a gift letter in your funds verification to reassure your lender about the source.
Consider Down Payment Assistance
Down payment assistance may be available from nonprofit organizations, government entities, or lenders. Eligibility may be based on factors such as income and location, but assistance is typically more widely available to first-time home buyers. You may be able to search for programs such as grants, deferred loans, or funds matching.
Benefits of a Large Down Payment
What is a down payment if not a financial head start? Paying more for your down payment can open more doors for you during the lending process. You will likely qualify for more loan opportunities, meaning you can compare and shop for the best loan terms.
You may also receive lower interest rates, monthly payments, or closing costs and be able to avoid paying for private mortgage insurance (PMI). Finally, a larger down payment gives you more equity in your home, which means you own a larger percentage of it from the start.
Benefits of a Small Down Payment
A small down payment may not get you the best loan terms. However, it does allow you to start searching for homes sooner. Since you don’t need to spend as much time saving, you’ll be able to get into the housing market earlier.
