What Is a Down Payment? How It Works and How Much You Need

With the median U.S. home price topping $400,000, very few people can afford to purchase a home in cash. Homebuyers typically finance their purchase, but most home loan lenders require a down payment, which is an upfront cash payment equal to a percentage of the purchase price. 

The average down payment among first-time homebuyers is 9%, but some people are eligible for financing with as little as 3% or even 0% down. However, there are advantages to putting down more than the minimum, and deciding how much to save for a down payment can be a difficult decision.

We’ll cover how down payments work, how to decide how much to put down, and where the money should come from. We’ll also walk you through an example scenario, so you can see how your down payment affects your mortgage costs. 

What is a down payment?

A down payment is a percentage of the purchase price paid upfront in cash. To qualify for a mortgage, you’re often required to provide some amount of down payment. However, different home loan programs and lenders have their own down payment requirements. 

The amount you put down will affect the type of mortgage you’re eligible for, your mortgage rate, and your monthly payment, including whether you’ll have to pay mortgage insurance (MI).

How do down payments work?

Your down payment is due at closing. You will receive a closing disclosure at least three days prior to your closing date, which will specify the amount due. 

Some of the down payment money will likely come from your earnest money deposit. While the law doesn't require earnest money deposits, most homebuyers put a deposit into an escrow account after the seller accepts their purchase offer. 

Deposits typically range from 1% to 20% of the home purchase price, depending on the property and local market. If the sale goes through as planned, your earnest money deposit is typically applied to your down payment amount due at closing. 

How much should your down payment be?

You’ll need to fulfill the down payment requirements for your desired loan type, but there are also other factors to consider when determining your down payment amount, including:

• Financing costs: The more money you put down, the less money you finance with interest. “This is where a small number upfront grows to a large number over 30 years,” says Erik Leland, Lake Oswego real estate broker at Realty First. A larger down payment can also sometimes earn you a lower interest rate. 
• Mortgage insurance: Mortgage insurance is an extra monthly cost that most lenders charge if you put less than 20% down. If you can put at least 20% down on a conventional loan, you can avoid private mortgage insurance altogether. If you can put at least 10% down on an FHA loan, you’ll pay annual mortgage insurance premiums for 11 years instead of the life of the loan.
• Lender’s DTI requirements: Making a small down payment could prevent you from qualifying for your desired loan amount. Conventional mortgage lenders typically allow you to have a maximum debt-to-income ratio (DTI) of 45%, but they prefer it’s 36% or less. “Some buyers get priced out of a home not because of the purchase price, but because the lower down payment pushes their monthly obligation past the lender's DTI threshold,” Leland says.
• Cash after closing: Putting all your savings into a down payment is risky if it leaves you without an emergency fund. “I always caution buyers not to drain every dollar they have just trying to hit some magical down payment percentage,” says Ernie “Big Ern” Becker, broker and owner at United Real Estate Queen City. “Sometimes keeping extra cash reserves available for repairs, upgrades, or emergencies can make more sense.”
• Housing market: In a competitive market where multiple offers are common, a larger down payment can make your offer look stronger to the seller, according to Becker. But in other cases, it might be wise to strike while the iron is hot rather than saving for a larger down payment. “In the right housing market, getting access to home equity sooner can be incredibly valuable,” says Landy Liu, CEO of Foyer, a homeownership platform. 

Here are some common loan types and minimum down payments.

How do you pay for the down payment?

With the median U.S. home sales price currently sitting at $403,200, saving even a 3 to 5% down payment can seem intimidating. Fortunately, there are multiple ways to pay for a down payment. 

• Savings: Almost 70% of first-time homebuyers use savings to fund their down payment, according to the National Association of Realtors. 
• Gift money or inheritance: Homeownership is less affordable for young people today than it was for previous generations, so many first-time homebuyers get help from friends or family. One-quarter of first-time buyers relied on gifts from relatives or friends to help fund their down payment, and 7% had help from an inheritance. 
• Down payment assistance programs: Down payment grants and low or no-cost second mortgage loans from state and local governments or nonprofit organizations are available in many areas to help first-time homebuyers or underserved populations. Many programs have income limits or other requirements. 
• Home equity loan or HELOC: “Homeowners can use a HELOC or home equity loan from their current home to help fund the down payment on another property,” says Becker. “I see move-up buyers do this fairly often, especially when they want to buy before they sell, or when they plan to keep the current property as a rental.” But make sure you have cash reserves and a long-term financial plan.
• Piggyback mortgage: Homebuyers may also be eligible for a piggyback mortgage, which is a home equity loan or HELOC on the property secured by the first mortgage to cover a gap in the down payment. The second mortgage typically comes with a higher interest rate, but it may help you avoid private mortgage insurance. 
• Retirement funds: Some homebuyers turn to their retirement account to afford homeownership. When using a 401(k) loan to purchase your primary residence, many plans allow repayment over a term longer than five years. However, you must  repay the loan with interest to avoid an early withdrawal penalty unless you meet an exception. Early withdrawals up to $10,000 from IRAs and certain other retirement accounts are exempt from a tax penalty for qualified first-time homebuyers. 

Example of down payment scenarios

Making a larger down payment typically means that you’ll spend less on mortgage interest and fees, but there are disadvantages to tying up all your money in your house. For example, there may be an opportunity cost associated with not investing the money in the stock market, and you may be left without a safety net in case of emergencies. 

Determining a down payment amount is a difficult decision, so it’s helpful to calculate how different down payment scenarios affect your mortgage over time. The impact of your down payment on your financing costs also depends on how long you plan to stay in the home. 

Let’s say you’re taking out a 30-year fixed-rate mortgage on a $300,000 home. You could:

• Put down 20%, or $60,000, and finance $240,000
• Put down 10%, or $30,000, and finance $270,000
• Put down 5%, or $15,000, and finance $285,000

Here’s how each of these scenarios looks after five years, assuming a 6.5% interest rate. You can use the Freddie Mac Private Mortgage Insurance Calculator to compare scenarios using your own home purchase price. 

The 20% down payment has the lowest monthly payment and interest costs and allows you to build the most equity. In the other examples, a substantial amount of your payment goes to interest and private mortgage insurance rather than building equity. 

That said, if the 20% down payment completely drains your bank account, an emergency could expose you to financial trouble. Paying interest on unsecured loans or credit cards could easily wipe out any savings from opting for the larger down payment. 

There’s one caveat to consider, though — the 20% down payment could help you qualify for a HELOC sooner, which is one of the cheaper ways to borrow if an emergency home repair catches you off-guard. 

“The real key is balance,” says ‘Big Ern’ Becker. “Every loan and every buyer situation is different, which is why buyers really need a qualified mortgage professional to explain the best overall strategy for their situation.”

How to save for a down payment

“The best way to save for a down payment is in a dedicated account, with steady savings through a recurring transfer from each paycheck,” Liu says. 

Keep your cash in a high-yield savings account, where it can earn a higher annual percentage yield (APY) than the national average. Some accounts currently offer up to 4.00% APY or higher. To reach your home savings goal faster, trim your budget to reduce unnecessary spending and deposit any windfalls, like bonuses or gifts, directly into your down payment fund. 

“Just as important is doing the research to find programs, grants, and assistance options that can help close the gap faster,” Liu says. “In practice, some buyers who feel priced out are closer than they think once they identify grants or state-backed loans that better fit their budget, timeline, and home goals.”