The down payment—especially here in Seattle—intimidates many new buyers. I’ll de-mystify things a bit and show you a few options. (I’ll assume you’re qualified for a loan and have a good credit history. If that’s not the case, you have a few different options that we can talk about one-on-one.)
To start off, what’s the purpose of a down payment? Your lender will front most of the money, but they don’t want to be the only one putting money at risk. Hence, the down payment. The down payment ensures that you’re financially invested, too. In the event of foreclosure, your down payment will be the first money lost.
A typical down payment is 20% of the home’s value. The exact amount you put down depends on your specific situation and the housing market. If you can pay 20%, you’ll usually get better financing options (and you’ll pay less each month with a larger down payment). A down payment greater than 20% rarely yields a better interest rate, so I wouldn’t recommend planning for that.
The lowest you can go is usually 5% for a down payment—but most conventional mortgages (non-government-backed) with less than a 20% down payment require Private Mortgage Insurance (PMI). PMI isn’t a bad thing—it just means you pay extra, and in return, the bank takes on more risk. Depending on your specific situation, this can be a useful move, or an unnecessary move.
There are three main to pay PMI:
- A fee added to your monthly payment (0.5% to 1% of the house price/year, paid monthly—the exact amount depends on your down payment and credit score)
- A higher interest rate for the lifespan of your loan (about 0.25% more)
- A one-time extra payment. Instead of of monthly surcharges, you pay roughly 3% of the house price up front. This extra payment doesn’t go towards your equity, unlike a down payment.
If you choose the monthly surcharge, those payments can end after you pay down the principal of your loan to below 80% of your original purchase price. This can take a long time, especially if you only make minimum payments and paid a tiny down payment, but if you pay down your mortgage aggressively, you could eliminate PMI in a few years. (Note: paying down your mortgage isn’t always the best use of your money, investment-wise. I’d be happy to talk more about your options.)
As an another option (if you qualify), the government guarantees other mortgage products with reduced down payment requirements, such as FHA, VA and USDA loans. The government takes on some of the risk, not just the lender, which allows for a reduced down payment. To qualify for a VA loan, you must be a veteran. To qualify for a USDA load, you must live in a semi-rural area (and it helps to have low income). FHA loans aren’t as beneficial, as you must pay their version of PMI, called MIP.
