Down payments: A homebuyer's guide

Is the purchase of your dream, or maybe your first, home within reach? The answer likely depends heavily on your down payment. This crucial first step in home buying is often misunderstood, yet it plays a significant role in the timing, cost and often the mortgage terms you ultimately receive. A down payment isn't just an upfront cost; it is generally viewed as an indicator of the level of risk your purchase presents to the mortgage company and there can frequently be additional costs in the form of mortgage insurance and/or higher rates for lower down payments. Let's explore how some of these considerations can impact the purchase process and, ultimately, household budget.

What is a down payment and why is it important?

A down payment is your first equity stake in a home. It's the part of the purchase price that you pay out of pocket, typically between 3.5% and 20% or more. Lenders require a down payment to reduce their risk. It's your commitment that also provides them with a safety net if you default on your mortgage.

In the past, a 20% down payment was standard, offering the best interest rates and eliminating the need for mortgage insurance. But with escalating home prices, accumulating such an amount has become more challenging for many buyers, particularly those purchasing for the first time.

The influence of rising home values on down payments

As home values climb, so do the necessary down payments. With the median down payment on a home in the U.S. reaching $51,250 by December 2023 (more than double the average from just 5 years ago), buyers need to save more to secure a property. This lump sum has grown substantially, even as the percentage put down has dropped to 8-13% from previous averages closer to 20%.

This rise in home values, achieving record highs in many markets, forces buyers to save longer to amass larger down payments, potentially delaying their purchase.

Delayed homeownership and its effect on net worth

The rising trend of larger down payments has caused many, especially younger people, to delay buying a home. The ramifications of this delay on an individual's net worth can be considerable. Owning a home is often a critical element of wealth accumulation, as properties generally appreciate over time, and mortgage payments build equity as opposed to rent payments, which have no financial return.

Delaying the purchase of a home means potentially forgoing years of equity growth and its financial advantages. It's a complex challenge that highlights the importance of early planning and saving for a down payment.

Mortgage payment consequences of a lower down payment

Given the increasing challenge and time needed to save for a down payment, many buyers are choosing to make a smaller down payment and bearing the increased mortgage costs that follow. With less than 20% down, you'll have a larger loan and generally need mortgage insurance, which protects the lender at your expense. Both of these factors tend to increase the buyer’s monthly mortgage payment and cause a higher housing burden in the budget. Lenders also tend to view home buyers with lower down payments as riskier and may charge higher interest rates.

As a rough example, buying a $500k home with a 90% LTV mortgage at current interest rates will result in a mortgage payment right around $3,300 due to the need for mortgage insurance and additional principal being financed. That same transaction with an 80% LTV mortgage would generally avoid mortgage insurance and the financing costs of the extra $50k and result in a payment more like $2,660 … or a monthly savings of $640.

A down payment is a fundamental element of your journey to homeownership, influencing not only your monthly payments but also your overall financial stability. Exploring a down payment co-investment with CribEquity could be the missing piece to your home purchase puzzle that takes the 10% you have saved for a down payment and increases it to 20%.