What Is a Minimum Down Payment?
The minimum down payment is the cash contribution that a borrower must provide from their own funds when they purchase a home. The actual amount required varies by the loan program, but the standard minimum down payment required for a conventional loan is 20% and 3.5% for an FHA loan.
- The minimum down payment is the cash that a buyer is required to provide to qualify for a mortgage loan.
- For a conventional loan, the down payment is typically 20%, while for an FHA loan, it is typically 3.5%.
- The down payment is designed to offset the risk to the lender.
- FHA loans are government-backed loans. These loans require payment of a tax-deductible monthly mortgage premium known as mortgage insurance to offset the low down payment.
Understanding a Minimum Down Payment
Minimum down payment amounts are required to offset the potential risk to a lender. The theory is that a borrower will be less likely to default on a loan when they have made a large cash contribution to the mortgage themselves.
For conventional loans that are backed by various lending institutions, this amount is typically 20%, which is due at the signing of the closing documents. Government-backed loans, also known as FHA mortgages, offset this risk by collecting a monthly mortgage premium known as mortgage insurance or MI.
As of 2018, the mortgage insurance premium is a tax-deductible expense.
Example of a Minimum Down Payment
Consider, for example, that Mary Smith is looking to purchase a home. She has received preapproval for a $360,000 mortgage and has found a home that she would like to buy. The purchase price is $350,000. With a conventional mortgage, Mary will be able to borrow up to 80% of that purchase price, or $280,000. That means she will need to come up with 20%, or $70,000 of her own funds to close on the loan.
If we look at Mary’s mortgage again (this time using FHA guidelines), we see that instead of borrowing 80% of $350,000, Mary can borrow up to 96.5 percent, or $337,750. That means Mary now only needs to find 3.5% of $350,000, or $12,250.
However, now Mary will be required to make a monthly mortgage insurance payment in addition to paying principal, interest, taxes, and 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. This premium is escrowed into the monthly payment.
The minimum down payment typically required for a conventional mortgage loan.
There are many factors to consider when deciding which type of loan to pursue, including the qualification requirements. However, one thing remains the same, the minimum down payment is just that, a minimum. 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 should be based on the amount a borrower can afford and what they consider to be their best option financially.
As of 2019, the mortgage insurance premium is a tax-deductible expense.