How Much Money Should a First-Time Home Buyer Put Down?

Key Takeaways

• The more you put down, the more equity—or ownership—you have in the house.
• Putting money down reduces your loan to value ratio (LTV).
• Remember that rate isn’t everything.

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Hint: Maybe not as much as you think

It’s tempting, when thinking about buying a first home, to compare the price of a month’s rent to that of a monthly mortgage payment—apples to apples. So, if your rent is $1,000 and the mortgage payment would be $1,000, why not buy the house? Except that it’s not exactly equal. Rent is an apple; buying a home is a whole fruit basket. It includes property taxes, upkeep, homeowner’s insurance, and that seemingly huge hurdle: the down payment. So how much down payment do you need for a house for a first-time home buyer?

20 percent down payment

Most lenders would love a 20% down payment. It signals to them that you’re willing to put skin in the game and makes it safer for them to lend money to you. You pay the down payment and borrow the rest of the money for the house from the lender, then pay it back over a period of years. The more you put down, the more equity—or ownership—you have in the house.

You’ve probably already heard making a 20% down payment can save tons of money for your future self, and that’s absolutely true. But how does that compare to a scenario where you didn’t make that down payment?

Here’s a hypothetical scenario without a down payment:

• Home price: $200,000
• Interest: 4.5%
• Term: 30-year mortgage
• If you borrow the whole amount, you wind up paying a grand total of $364,813 over the life of the 30-year loan -- almost twice the original price of the home

However, if you buy the same home with 20% down:

• Home price: $200,000
• Down payment: $40,000
• Loan amount: $160,000
• Interest: 4.5%
• Term: 30-year mortgage
• You only wind up paying $291,851 over the life of the 30-year loan

In fact, it might be lower than that, because if you put money down lenders usually consider you a safer bet and reduce the interest rates even further.  Putting money down reduces your loan to value ratio (LTV), the ratio of how big your loan is compared to how much your house is worth. A lower LTV makes you a more attractive borrower.

The extra cost of mortgage insurance

If you put 20% down, you won’t have to pay Private Mortgage Insurance (PMI). Sometimes people call it Mortgage Insurance Premium (MIP). Either way, it is an insurance policy that lenders take out on your mortgage in case you don’t make payments. There are different ways lenders administer these insurance policies. PMI, which is the insurance vehicle on conventional loans generally costs between .5% and 1% of the price of the loan, every year.  

If you buy a $200,000 house with a required 1% PMI, this will cost you $2,000 extra dollars a year; or an extra $166 a month.

So again, it’s another reason to put 20% down if you can. However, most people don’t have a spare $40,000 floating around today to make life easier for their future selves when buying a first home.

What if you don’t have 20 percent?

The National Association of Realtors found that 88% of home buyers in 2017 financed 90% of their home purchase. New home buyers financed 95%. The most common down payment is between 5-to-10%.

That means first time home buyers must figure out how much house they can reasonably afford, and whether they can come up with at least 5% of that from their savings or another source for a down payment.

Most experts agree you should pay no more than 25%-to-30% of your monthly income on your mortgage. That includes homeowner’s insurance, PMI, and property taxes, which are often rolled up into the mortgage payment. That doesn’t even include potential Home Owners’ Association (HOA) dues.

Crunch the numbers for yourself

Using a mortgage payment calculator, you can play with the numbers. Until you get qualified for a loan from a lender, you’ll be guessing, because the interest rate you receive will impact how much your monthly payment will be — the higher your credit score, the lower the interest, and vice versa. Bankrate lists the day’s average interest rates to help you play with the numbers.

Property taxes depend on the value of your home. For example, the proposed 2018 rate in Dallas County is $0.253100 per $100 of taxable value. At that tax rate, if your home is worth $200,000, you’ll also have to pay $506.

Home owner’s insurance prices ride on a lot of factors, including the age of the house, the neighborhood, and whether it’s in an area prone to things like hurricanes. The average cost in Texas is $1,945. That’s an additional $162 a month. All these numbers can go up or down depending on your credit score and what mortgage lender you use.

PMI is generally between .5% and 1%.

About mortgage points

Often you see that a loan advertised at a number of points. Points is a term that pretty much means money you pay ahead of time to reduce your interest rate and therefore your payment. Paying down points is not considered a down payment, but it is considered pre-paid interest. Paying points can sometimes make it easier to make a smaller down payment, depending on your lender’s rules. Points are typically equal to 1% of the loan rate and can reduce your interest rate by up to .25%. The longer you plan to be in the house, the smarter an investment in points becomes.

How much mortgage can you afford?

Let’s say you can afford to pay $1,500 a month and that means you can get that $200,000 house with room to spare. How much do you put down?

Obviously, the more you can afford to put down, the lower many of these numbers will go, reducing your monthly expenses. Common sources of a down payment include:

Cash from savings and checking accounts

Savings bonds, IRAs and 401K accounts, investments

Gift funds

Money from the sale of personal property

Funds for a down payment must be documented and typically in an account for a certain period of time. According to the National Realtors Association, almost 60% of buyers in 2017 used their savings for a down payment. 43% saved up for six months or less.

Prospective homeowners might set up a savings account just for the down payment, take up a side gig, or sell an extra car.

Alternatively, look for a less expensive house that requires a smaller down payment. Some people can also get zero down loans for their home with lenders who go through the Federal Housing Administration, the Veterans Administration, or the United States Department of Agriculture. New home buyers need to meet certain criteria such as having a credit score within a certain range, have at least a specific amount of income, or being a veteran. There may also be property requirements.

What you don’t want to do is drain all your savings or investment accounts to put into a house. That might look like a prudent investment, but it’s dangerous. In the economic downturn of 2008, people had bought the most expensive houses they could afford because the housing market has consistently gone up over decades. They figured they’d live in a nice house and make a fortune when they sold it. But when the economy hit a rough patch, they had no money because everything was going toward the house. They couldn’t make their mortgage payments, and millions wound up in foreclosure.

Get your first mortgage with a lender you can trust

Remember that rate isn’t everything. Sometimes going with a lender you can trust is better than getting the lowest rate possible. One reason interest rates tend to be low is that some mortgage companies use your loan as a money maker—they buy and sell the loan, and you might wind up dealing with several different lenders over time.

Other lenders, like Credit Union of Texas, do not engage in this practice. We build relationships with our members and work to help them build the loan terms and plan that help them reach their long-term goals… and take care of not only their present but their future selves. We’d be honored to help you get your first mortgage loan.