A down payment is when you pay a fraction of the cost of a home upfront and take out a loan to cover the rest.
You don’t have to put 20% down on a house
A common misconception is that 20% is the standard down payment on a house. That’s not the case, according to Melissa Cohn, regional vice president at William Raveis Mortgage.
Instead, depending on what kind of mortgage you take out and what kind of homebuyer you are, you can pay as little as 3.5% down. And if you’re taking a mortgage from the Department of Veterans Affairs or the U.S. Department of Agriculture, you could get a loan without putting anything down.
First-time homebuyers are more likely to qualify for lower payment options, but there are a variety of grants and programs lenders offer to all kinds of buyers.
A smaller down payment means bigger monthly costs
Paying a smaller fraction of the cost of your home upfront means your monthly mortgage payments will be steeper. That’s for two reasons.
One: You have more of the payment to make. If you put 5% down on your house, that means you need to pay off a loan for 95% of the total cost. But if you put 20% down, you have to pay off only the remaining 80%.
Two: If you make a payment lower than 20%, you’ll have to pay for private mortgage insurance each month, according to Cohn. The extra payment is basically a backstop for the lender in case you default on your loan.
“Depending on your credit score, mortgage insurance can be very expensive,” Cohn said.
"Today, the average cost of private mortgage insurance is about 0.4 percent of the amount of the loan," Bankrate has reported. "If you were paying PMI on a $400,000 loan, for example, your premium would be $1,600 a year, or about $133 a month.
What if you are gifted money for a down payment?
If you receive money from a friend or family member to pay your down payment, there are certain requirements that have to be met.
First, it needs to come from a source that your lender allows, according to Jennifer Beeston, a mortgage originator at lender Rate. Some loan programs allow gifts only from certain people, such as a family member or spouse.
It also has to be a "real gift," Beeston said. For example, if your mom gives you $20,000 for a down payment, but you have to pay her back within five years, that's a loan, so it can't be used as a down payment.
When you receive the gift also matters. If, for example, guests at your wedding two years ago crowdfunded for a down payment as a gift, you probably won't have to do anything to prove those funds are a gift because they've been in your account for so long.
But anytime you are receiving a gift during your mortgage transaction, you should be upfront and transparent with your lender, according to Beeston.
"Every single lender is going to require a gift letter if someone's giving you funds during the transaction," she said. "So just be aware and make sure you're talking about it with your lender so you don't end up with some big deposit in your account that we can't use."
Down payment assistance is 'hyperlocal'
If you don't have the money for a down payment, there are programs that offer assistance.
They operate on a "hyperlocal" level, according to Beeston, so you'll need to work with your loan officer to determine your best options.
Beeston warned that borrowers should be wary, though, and understand all the terms of the program.
"One thing to watch out for is sometimes there'll be programs that aren't that great where you'll end up with a higher interest rate or higher fees," she said.
Picking the right down payment for your budget
Though there are benefits to making a large down payment, it’s also important to be realistic with your money, according to Lauren Lindsay, a financial adviser in Houston.
“Don’t put all your cash into it,” Lindsay said, “especially if there are repairs you think you may need to do. There’s also furniture you didn’t know you needed and things like that. So don’t wipe out your emergency fund.”
Lindsay said the key is finding a balance that gives you a down payment that doesn’t take from your emergency savings and doesn’t leave you with a monthly payment that’s too high.
All told, Lindsay suggested trying to keep your payment at about 25% or less than your take-home pay, but she acknowledged that isn’t always possible.
At the same time, though, it’s important to see the big picture, and that may mean adjusting your budget to fit a monthly payment that will make sense in the long term.
“What is more important? Is homeownership more important than the things you’re doing that you have control over?” she said, suggesting that it could be worth cutting out expenses like eating out or taking vacations to fit mortgage payments into your budget more easily.