How Much Should You Save for a Down Payment?

When our minds wander through the journey of home buying we ponder a lot of questions, like "How many bedrooms?" "Which neighborhood?" and "Will we paint the front door black or red?" One day we expect to be looking at properties and wrestling with those choices for real. But first, we know we need to save for a down payment.

In the most basic terms, how much you must save for a down payment depends on the requirements of your mortgage. It's a share of the home price that you must pay first, then the mortgage covers the balance. Your average lender offers loans for 10% or 20% down; some offer as little as 5%; VA loans are extraordinary in that they can require 0% down.

That's how much you must save for a down payment, but figuring out how much you should save means taking into account the benefits you get with more money down, like being free of sizeable insurance payments. Down payments are cash, and cash talks. What does the size of the down payment mean to lenders and to you?

The average down payment for a newly built home today is about 6%, according to Forbes, which wrote, “There are ramifications for putting less than 20% down.”

What Your Down Payment Says to Lenders

"This person is responsible," your down payment says right away. It's the first impression in the mortgage relationship, so to speak. Come to a lender with a dream of home ownership and empty pockets, and the lender sees but a dreamer. A down payment says you're serious about making the dream come true.

Mortgage lenders want to see that your finances are in order. They look at your income and debt, credit profile, and job history. A down payment says, "This person has the discipline to save money." The more you've saved, the better you look. Lenders see a 20% down payment as a good sign that you handle money well and would be less risky to do business with.

Putting 20% down tells the lender you're willing to invest a serious amount of your own money in your home. With a dog in the race, you are less likely to miss mortgage payments. Because the lender has more confidence in you for putting 20% down, you don't have to carry private mortgage insurance (PMI), a significant savings.

Lenders look at the loan-to-value ratio when evaluating your mortgage. A 5% down payment means the lender would be loaning you 95% of the home's value. The comfort zone for lenders is to loan 80%.

What Your Down Payment Means for You

Putting more money down means you have to borrow less, the advantages of which are obvious. Less of your hard-earned money goes to interest, and your monthly payments are lower. Even if you can't reach the sweet spot of 20% down and 80% borrowed, the more you put down always means the less you have to borrow.

We call 20% down the sweet spot because that's when lenders won't make you carry private mortgage insurance. This saves you anywhere from 0.3% to 1.15% on your home loan. These insurance payments are usually paid monthly but can be tacked on to the cost of the loan. PMI is insurance that you pay to cover the lender's risk, and you're stuck paying it until you've attained 20% equity in your home.

Buyers who put more money down qualify for lower interest rates. The difference won't be big—rates today are already very low—but when you're talking about a price tag as big as a house for as long as 30 years, every percentage point matters.

A smaller down payment makes it harder to qualify for a mortgage. We don't just mean that it leaves lenders less confident about investing in your home with you; we mean it worsens your debt-to-income (DTI) ratio, which is a key determiner in who gets a mortgage and who doesn't.

DTI is the money you owe each month compared to what you make. In general, to qualify for a mortgage, this ratio shouldn't exceed 36%. (There are exceptions, too rare to discuss here.) Your DTI is simply your total monthly debt payments divided by your monthly earnings (before taxes). For example, if your gross income is $2,800 a month and you pay $550 for credit cards, an auto loan, and other debts, your DTI is 20% (550 ÷ 2,800). There are two major flaws built into DTI (gross income isn't what you actually take home, and life has a lot more monthly expenses than just debt payments), but since all lenders calculate DTI the same way it works for them as a measure of how comfortably a person can make mortgage payments.

PMI is insurance you pay to cover the lender, not yourself, and you're stuck paying it until you've attained 20% equity.

Sources for Your Down Payment

Your down payment can come from savings, gifts, and grants. Lenders have to verify the sources of your down payment. Gifts cannot be friendly loans like, say, your uncle handing you a stuffed envelope on your wedding day and saying, "This is for a down payment." The giver will need to write a gift letter confirming that the money is a gift.

But First, Start Saving

In this article we talked about when you can stop saving for a down payment—when you have the minimum required for your type of home loan—but the most important advice we can give you is to start saving. You can't over-save towards a big purchase like a home. Wondering how much to save before you set aside the first dollar is like wondering where to retire before you start your first job.