How Does Down Payment Size Affect Savings for a First Home?

Economic models can help policymakers predict the effects of policies that affect down payment size. Prior research has shown that larger down payments lead some potential homebuyers to become discouraged and opt to continue renting, while other potential homebuyers increase their rate of savings or save longer before buying. Economist A. Talha Yalta developed a new model that incorporates this dual effect and calculates households’ likely rates of savings. The model does not account for households that may opt for a lower-cost home in response to down payment sizes.

Using the new model and data from the Panel Study of Income Dynamics, the author examines whether down payment size explains households’ savings patterns. The 1996 wave of the survey included questions about mortgage shopping, down payment size, and the source of funds used for the down payment. The author viewed savings behavior from 1989 for people who obtained a mortgage between 1993 and 1995 and reported using their own savings (not the proceeds from a home sale, gifts from relatives, or other sources) for a down payment. The sample ended up with 101 first-time homebuyers who used personal savings toward a down payment. The results confirm the connection between down payment size and savings behavior, and illustrate other factors that influence savings.

Key findings:

• Households save almost twice as much when trying to amass a down payment compared with households not saving toward a mortgage.
• The median rate of savings for first-time homebuyers who relied on savings for their down payment was 13.7 percent, compared with a 7 percent rate of savings among households without a mortgage.
• Married households seeking a mortgage save at a rate almost twice that of nonmarried households.
• Age increases the rate of savings for households seeking a mortgage.
• As family size goes up, the rate of savings among families seeking a mortgage goes down.
• The model suggests that a 1 percent increase in the size of the down payment causes a 0.5 percent increase in savings among households who go on to purchase a home.
• If the required down payment increases too much, households’ rate of savings will go down substantially as they become discouraged and abandon the plan to buy a home.