Minimum Down Payment: What It Means, How It Works, Example

What Is a Minimum Down Payment?

The minimum down payment is the cash contribution that a borrower must provide when purchasing a home. Many mortgage loans require a minimum down payment, which is typically 20% of the home's purchase price for conventional mortgage loans.

However, the actual amount required varies by the loan program. For example, the minimum down payment is 3.5% for an FHA loan, which is a mortgage loan insured by the Federal Housing Administration (FHA), and some veterans' loans or VA loans don't require any minimum down payment.

Understanding a Minimum Down Payment

Minimum down payment amounts are required to offset the potential risk to a mortgage lender. The theory is that a borrower will be less likely to default on a loan when they have contributed a large cash amount to the mortgage.

For conventional loans backed by various lending institutions, this amount is typically 20%, due at the signing of the closing documents. Government-backed loans, also known as FHA mortgages, reduce the risk of loss for the lender by collecting a monthly mortgage premium from the borrower, known as mortgage insurance. If the borrower defaults on the loan, the FHA compensates the lender for the unpaid portion of the mortgage loan.

Example of a Minimum Down Payment

Consider, for example, Mary Smith who is looking to purchase a home. She has received preapproval for a $360,000 mortgage and found a house she would like to buy. The purchase price is $350,000. With a conventional mortgage, Mary can borrow up to 80% of that purchase price, or $280,000. That means she must come up with 20%, or $70,000, of her own funds to close on the loan.

If Mary applies for an FHA-backed mortgage, Mary can borrow a higher amount and put down a smaller down payment. Instead of being restricted to borrowing 80% of $350,000, Mary can now borrow up to 96.5%, or $337,750, which means Mary only needs to put down 3.5% of $350,000 or $12,250 at the loan's closing.

However, now Mary will be required to make a monthly mortgage insurance payment in addition to paying principal, interest, taxes, and homeowners' insurance. The monthly mortgage insurance premium rate varies between 0.3% and 1.5% of the original loan amount and is based on several factors, such as the borrower's credit score and loan-to-value ratio. The premium is paid monthly and escrowed, or retained, to ensure payment of insurance.

Down Payment Assistance

Down payment assistance programs are available for borrowers who may have difficulty paying the large down payments usually required to buy a home. The program might be run by a federal, state, or nonprofit organization.

The programs may have eligibility requirements that include income limits for borrowers or might be capped based on the price of the home. You will need to apply to the program and may need to provide income documentation. Each state has its own version of mortgage down payment assistance programs that may include a loan or grant.

The Bottom Line

There are many factors to consider when deciding which type of loan to pursue, including the qualification requirements. However, some type of minimum down payment is usually required. A borrower can choose to put as much or as little down as they would like, depending on their lender's minimum loan amount requirements. The decision of the size of the down payment for a mortgage should be based on the amount a borrower can afford and what they consider their best financial option.