Down Payment

A down payment is the portion of a purchase price a buyer pays in cash rather than financing. In a home purchase it determines how much of the property's value the lender is advancing, expressed as the loan-to-value ratio, and that ratio in turn drives whether mortgage insurance is required, what rate the lender offers, and how much equity the buyer holds on day one. The FHA statute calls the same thing a "cash investment" (12 USC 1709(b)(9)), which is a fair description of what it is: money that stops being liquid and becomes part of the house.

Three widely repeated claims about down payments are wrong in ways that cost money, and correcting them is most of what this page is for.

"You need 20% to buy a house" is false. Twenty percent is the threshold at or above which a conventional loan carries no private mortgage insurance; it is not a condition of borrowing. The real minimums are much lower, though each one carries an eligibility condition worth knowing before you count on it. Fannie Mae's Selling Guide allows a one-unit principal residence to go to a loan-to-value ratio of 97%, which is 3% down, but for a purchase above 95% it requires that "at least one borrower must be a first-time homebuyer," meaning someone who has not held an ownership interest in a property in the last three years (Selling Guide B2-1.3-01). A repeat buyer's usual conventional floor is therefore 5% down, unless they qualify on income for HomeReady, which reaches 97% without the first-time condition. FHA requires "an amount equal to not less than 3.5 percent of the appraised value of the property" (12 USC 1709(b)(9)(A)) and asks nothing about whether you have owned before. VA states there is no down payment required as long as the sales price is not higher than the appraised value, and no mortgage insurance either, in exchange for a one-time funding fee; eligibility rests on military service. USDA's Single Family Housing Guaranteed program offers 100% financing, limited to an eligible rural area and to households at or below 115% of area median income. What a small down payment does cost is insurance, a higher rate in most cases, and a larger loan.

"You pay PMI until you reach 20% equity" is only half right, and the missing half is statutory. The Homeowners Protection Act sets three separate exits from private mortgage insurance on a conventional loan, and they do not work alike. On written request, you may cancel when the balance reaches 80% of the home's original value (12 USC 4902(a) with 4901(2)), provided you have a "good payment history," you are current, and you satisfy the holder's requirements on evidence of current value and on there being no subordinate lien. The servicer must terminate coverage automatically when the balance reaches 78% of original value on the initial amortization schedule, "irrespective of the outstanding balance for that mortgage on that date" (12 USC 4902(b) with 4901(18)). And coverage ends at the midpoint of the amortization period regardless (12 USC 4902(c)).

Two details inside those rules decide what a borrower can actually do. The first is that paying extra principal accelerates the 80% request and does nothing for the 78% termination. The cancellation date is defined as whichever the borrower elects of the scheduled 80% date or the date the balance "based solely on actual payments" reaches 80% (12 USC 4901(2)(A)). The termination date has no such alternative and runs off the schedule alone. So prepayment buys an earlier exit only if you ask for it. The second is that the reference throughout is original value, meaning the lesser of sale price or the appraisal at closing (12 USC 4901(12)), not current market value. Appreciation does not carry you across either line by itself, which is why the request route attaches a condition about evidence that value has not fallen rather than a condition that it has risen.

"Good payment history" is defined precisely, and the two halves are easy to reverse. Under 12 USC 4901(4) it means no payment 30 or more days past due during the 12 months preceding the cancellation date or your request, and no payment 60 or more days past due during the 12-month period beginning 24 months before that date, which is the year before that one. The recent year is held to the stricter standard. A single 30-day late eight months ago can defeat a request that a 30-day late twenty months ago would not.

One exception sits outside all of this. Where a loan was classified as high risk at consummation, the request and automatic-termination rules do not apply at all; a non-conforming high-risk loan instead terminates when the scheduled balance first reaches 77% of original value, and the midpoint backstop still applies (12 USC 4902(g)). And when coverage does end, the servicer must return any unearned premiums within 45 days (12 USC 4902(f)).

"FHA works the same way" is the expensive one. It does not, and the reason is definitional. The Homeowners Protection Act applies to private mortgage insurance, which 12 USC 4901(13) defines as mortgage insurance other than insurance under the National Housing Act, Title 38, or Title V of the Housing Act of 1949. FHA, VA, and USDA coverage is written under exactly those statutes, so none of the cancellation rules above reaches it. FHA charges a government premium instead. Under HUD's Single Family Housing Policy Handbook 4000.1, Appendix 1.0, for a mortgage term longer than 15 years the annual mortgage insurance premium runs for 11 years when the loan-to-value ratio at origination is 90% or below, and for the entire mortgage term when it is above 90%. An FHA borrower who put the minimum 3.5% down therefore pays the premium for the life of the loan and cannot cancel it at 80% or 78% no matter how much equity accumulates. Refinancing into a conventional loan is the only way out. For a large share of first-time buyers, who use FHA precisely because the down payment is low, the familiar advice about reaching 20% equity simply does not apply.

That difference is one of kind rather than degree, and it affects how much either rule can be relied on. The 80% and 78% figures are set by statute, so changing them takes an act of Congress. The FHA durations are administrative, set by HUD in the handbook, and HUD has moved them before, which is why the current appendix is the thing to check rather than a remembered rule.

The cost of a larger down payment is real, and it is not only opportunity cost. Money put into a house earns the mortgage rate you avoid paying, which is a certain return and a respectable one when rates are high. But it becomes illiquid in a way a portfolio is not: getting at it later requires selling the house or taking a new loan against it, and neither is quick or free. Down payment money is also not emergency reserves, and closing costs sit on top of it rather than inside it, so a buyer who empties every account at closing owns a house with no cushion against the first repair. The trade-off runs both ways, and where it lands depends on the mortgage rate, what the money would otherwise do, and how much liquidity a household needs to sleep at night.

Down payment funds do not all have to be your own savings. Loan programs generally permit gift funds from defined sources with documentation, typically a gift letter and evidence of where the money came from, and lenders will ask. Earnest money paid at contract is separate but related, since it is normally credited toward the down payment or closing costs at settlement rather than being an additional cost.

You agree a purchase price, the lender appraises the property, and the loan is sized against the lower of price or appraised value. Your down payment is the difference, paid at closing along with closing costs. The resulting loan-to-value ratio determines whether mortgage insurance attaches and often what rate you are quoted, and once the loan closes that original value becomes the fixed reference point for the private mortgage insurance cancellation rules for the rest of the loan.

A hypothetical example. Amara is buying a $400,000 house. At 5% down she pays $20,000 and borrows $380,000, a loan-to-value ratio of 95% ($380,000 ÷ $400,000), so private mortgage insurance applies. At 20% down she pays $80,000 and borrows $320,000, a ratio of 80%, so it does not. The extra $60,000 buys her a $60,000 smaller loan; at a 6.5% rate that is about $3,900 of interest she does not pay in the first year ($60,000 × 0.065), plus the mortgage insurance premiums she avoids entirely. It also means $60,000 she cannot reach without selling or borrowing against the house.

The same numbers make "original value" concrete. If Amara takes the $380,000 loan, automatic termination of private mortgage insurance arrives when the scheduled balance reaches 78% of the $400,000 original value, which is $312,000, and she may request cancellation at 80%, which is $320,000. Both dollar thresholds are fixed at closing, because both are percentages of that original $400,000. If the house appraises at $500,000 three years later they do not move, though the appreciation may help her satisfy the condition that value has not declined. What she can move is the timing, and only on one of the two routes. Paying extra principal brings her to the $320,000 request point sooner; the $312,000 automatic date stays where the original schedule put it.

Pros

• A larger down payment means a smaller loan, a lower payment, and less total interest over the life of the mortgage.
• Reaching 20% on a conventional loan avoids private mortgage insurance altogether rather than paying it until a threshold arrives.
• Starting with meaningful equity lowers the chance of owing more than the house is worth if prices fall, which is what makes a forced sale go badly.
• Lenders generally price lower loan-to-value loans better, so the rate improves as well as the balance.

Cons

• The money becomes illiquid. Recovering it means selling the property or borrowing against it, and neither is fast.
• Waiting to accumulate a larger down payment has its own cost, in rent paid and in whatever the market does meanwhile.
• Emptying savings at closing leaves a new owner with a house and no reserve for the first repair, which is when repairs tend to appear.
• The return on the extra cash is the mortgage rate avoided, which may be less than the money could earn elsewhere, and it is not a return you can spend.
• Program minimums are low enough that a large down payment is a choice, and treating 20% as mandatory can delay a purchase for years without reason.