What is a down payment on a home?

If you're considering buying a house, you may have already started saving for a down payment — but you may not need to save as much as you think. According to a 2019 survey from the National Association of Realtors, 35% of respondents believed they would need to save 16% to 20% of the total home price for a down payment.

This isn’t necessarily the case, though. Many conventional loans, including Conventional 97 loans, let borrowers put down as little as 3%. Credit scores and other factors will determine the best loan scenario for your financial situation. Usually, though, you benefit from a higher down payment if you can afford it.

Essentially, a down payment is an upfront cash payment (calculated as a percentage of the home’s final sale price) made by the buyer at closing. For example, your bank may require 3% down on the $120,000 condo you plan to purchase, which would equal $3,600 cash due at closing. The cash you pay upfront reduces the loan principal, or the amount you need to borrow to buy the home.

The down payment requirement

A down payment is the amount of money you contribute upfront to the purchase of your new home — your down payment and the loan from the lender make up the total sales price of the home you’re buying.

Most lenders require some minimum down payment because it establishes the homebuyer’s equity, or personal stake, in the property. From a bank’s point of view, down payments are closely tied to default risk, which means the more equity a borrower establishes at the beginning of the loan, the more likely they are to pay back what was initially borrowed.

According to Jennifer Ashley, a mortgage loan officer at ConsumerAffairs, if a borrower has a marginal total debt-to-income ratio, above-average assets can offset the weakness of the approval. Underwriters know that liquid assets can be used unexpectedly for bills or to support a borrower when there’s a temporary reduction in income.

Overall, the borrower must have sufficient liquid assets to make the upfront payment, pay the closing costs and cover other expenses at the time of purchase.

How does a down payment work?

While there may be a minimum down payment set by the lender, you can choose to put down more. A larger down payment can lower your interest rate, which can result in significant savings over the course of the loan. It will also reduce your monthly payment amount. Your lender can provide you with an example of each down payment scenario you’re considering and how it affects your monthly payment.

It’s possible that a higher down payment may also increase your chances of getting your dream home if the seller has multiple offers to consider. The seller’s real estate agent can access your preapproval letter with your loan terms, including the amount the lender is willing to give you and the down payment you plan to make, when you submit an offer to buy a home.

In some cases, you can use gift funds from family members for your down payment — but this must be approved. Otherwise, loans are not allowed.

When a seller’s agent presents multiple offers, they may advise the seller to consider the down payment in addition to the offer price. A sizable down payment implies the buyer has adequate cash saved and may be less likely to let the deal fall through if repairs are needed on the home after the inspection.

Assets vs. gifts

Depending on your current financial situation and the mortgage program, you may be able to provide assets in lieu of a down payment — or you might be able to use gift money from family members. Assets are simply items of value a borrower can use to make payments in times of economic distress. The underwriter takes steps to verify the nature and the value of an asset provided by the borrower.

A Verification of Deposit (VOD) is sometimes used to verify current and average balances on your bank statements. Most lenders will want the most recent bank statements before closing so they can verify there’s enough money in the bank to pay the cost of buying the property.

Liquid assets include cash and anything that can quickly be converted into cash: checking accounts, savings, CDs, money markets, mutual funds, stocks and bonds, cash value of insurance and retirement accounts (and sometimes trusts), for instance. Nonliquid assets include sweat equity, employer assistance, rent credit, secured borrower funds, trade equity and unsecured funds.

With some programs, you can use gift funds for a down payment — make sure you talk with your loan officer to determine the specifics of these family-funded gifts. The gift should be confirmed by means of a gift letter, which is signed by the donor. Most companies have a form they’ll email you to complete early in the application stage.

Depending on your loan type, lenders might require you to name the source of any significant irregular deposit. According to Ashley, the reason for so many layers of underwriting verification is to show you haven’t borrowed funds without a lender’s knowledge or received a loan for the down payment — this is not allowed.

What is the minimum down payment on a house?

Down payment requirements tend to vary by lender and loan type. Your credit score and other factors play a role in how much cash a lender will require you to put down to get a mortgage.

Currently, the minimum down payment on conventional loans is 3% for first-time homebuyers (5% otherwise), but the required amount varies by lender.

The minimum down payment requirement depends on the borrower, the lender and the type of loan.

Down payment requirements for FHA loans are as low as 3.5%, according to the U.S. Department of Housing and Urban Development (HUD). However, these minimums vary based on your credit score. If your credit score is between 500 and 579, you’ll have to make a more substantial down payment of 10%. On a $250,000 house, that could be the difference between a $25,000 (10%) or $8,750 (3.5%) down payment.

VA loans have no down payment requirements, making them an attractive loan option for active-duty service members, veterans and certain surviving spouses. The lender may require a down payment if the home’s sale price exceeds the appraisal value, however.

You can also secure a USDA loan without a down payment. However, you will have to meet income and property eligibility requirements.

Jumbo loans typically have higher down payment requirements than conventional loans because of the greater amount of risk to the lender. Lenders usually require at least 10% down on jumbo loans.

How to save for a down payment

You can set aside funds for a down payment in a matter of months or years, depending on how soon you plan to buy a home and how aggressive your savings plan is. The first step to creating a savings plan is to estimate how much you will need to cover the down payment and other expenses, like closing costs. Once you have an estimate, you can then decide the timeline for your savings goal.

It’s always a good idea to have your credit pulled by a reputable lender to know if you’ll need any cash to pay off a debt, collection or tax lien before committing to buying a home. Some loan programs, if approved by the underwriter, will allow certain debts to be paid off at closing. This means you might have to come up with additional funds to pay your down payment, closing costs and any additional debt.

For most borrowers, saving for a down payment usually means cutting back on monthly expenses or increasing income — or a combination of both. One way to reduce monthly costs is to find a better deal on your car insurance or cell phone bill. Any savings can go directly to your savings account. You could also increase your income by finding a side gig, like tutoring students online or pursuing freelance opportunities.

Bottom line

Making a down payment is a requirement for most mortgage loans (except VA and USDA loans). This upfront cash payment establishes your equity in the property and reduces the principal on the loan. You may choose to pay the minimum required by your lender if you don’t have enough savings to cover other unexpected expenses that may occur during or after your home purchase.

However, increasing your down payment to at least 20% helps you avoid mortgage insurance and reduces your monthly payments overall. As you analyze different down payment scenarios, it’s best to consider their impact on your monthly payment, the estimated cash due at closing and the savings between the loan scenarios.

A good loan officer should provide you with at least two to three mortgage options. Sometimes there’s little difference in the mortgage payment — for example, a loan might require a 3% down payment, but the interest rate might be higher. Paying a 3.5% down payment with another loan program might mean a lower interest rate, though, so the savings might be insignificant. Just make sure to understand the terms and consequences of each to pick the right option for you.