How Do Down Payments Work?

How Do Down Payments Work?

Lenders see down payments as marks of good faith and evidence that the borrower is invested in a purchase and therefore less likely to miss their payments.

When you apply for a loan on a home, car or other large purchase, the loan offer will reflect the amount of the required down payment, the interest rate on the loan and any applicable fees. Your credit history is another factor, so a borrower with middling credit scores might be required to make a higher down payment than a borrower with excellent credit.

Different loan categories have different down payment requirements, and requirements may vary among lenders issuing loans of a given type. For example, the mortgage on a $400,000 house with a required 10% down payment of $40,000 would result in financing of 90% of the purchase price—$360,000.

Like other loan terms, down payments are negotiable. A lender may agree to accept a lower down payment in exchange for raising the interest rate. Conversely, you can often negotiate lower interest rates or fees in exchange for making a larger down payment.

Mortgage lenders typically require down payments to be made in the form of a certified check. Auto loan financers may require certified checks as well, but some accept electronic transfers, debit card payments or personal checks. Retailers that offer financing on appliances, furniture or other large goods may take down payments by cash, check or credit card.

What Is a Typical Down Payment on a House?

Mortgage lenders have a lot of freedom (within legal limits) to set down payment requirements, eligibility criteria, interest rates and fees on the loans they issue. Several general practices nearly universal among U.S. home lenders, however:

• When lenders issue mortgages with down payments of less than 20%, nearly all require borrowers to buy private mortgage insurance (PMI) on the loans. Because loans of more than 80% of a home's purchase price are considered risky, lenders require PMI to guard against losing money in case a borrower defaults and they must seize and resell the property. PMI premiums increase monthly mortgage payments, but you can have them removed after you've paid 20% of the principal on your loan. Making a mortgage down payment of 20% of your home price (or as close to it as you can manage) can minimize your PMI costs.
• First-time homebuyers with FICO^® Scores^☉ of 580 or higher can make down payments as low as 3.5% on FHA loans—mortgages backed by the Federal Housing Administration. Borrowers with FICO^® Scores as low as 500 also can qualify for FHA loans but must make down payments of at least 10% of the home purchase price.
• Qualifying veterans, service members and surviving spouses can purchase homes with zero down payment and no PMI requirements via a VA loan backed by the U.S. Department of Veterans Affairs.

What Is a Typical Down Payment on a Car?

Down payments of 10% are common when financing used vehicles, while down payments of 20% or more may be required when financing new ones, particularly if your credit scores are less than exceptional.

Even when a lower down payment is available, putting down more than 10% of a car's value is often prudent, as it can provide some insulation from the inevitable depreciation—loss of resale value—inherent in all but collectible vehicles. Cars lose value every year they're on the road, at rates determined by their mileage, condition and local market preferences.

Benefits of a Larger Down Payment

Putting down more than the minimum require down payment on a loan has several potential advantages:

• Borrowing less: With any given purchase, the more money you put down, the less you must borrow. Financing a lower amount means less debt and that in turn means lower overall borrowing costs, such as interest rates and fees, which are typically calculated as percentages of the loan amount.
• Lower interest rate: Making a down payment higher than the minimum required amount often allows you to negotiate a lower interest rate, which saves you money over the life of the loan.
• Lower monthly payment: Another consequence of borrowing less money is a reduction in your payment amount, which can make it easier to fit the loan payment into your monthly budget.

Benefits of a Smaller Down Payment

There may also be advantages to steering clear of a large down payment, whether you're still saving up your cash or you already have sufficient money to put down:

• Ability to make a purchase sooner: It takes time to save money and, depending on your income and eagerness to get into a home, it may make sense for you to make a lower down payment and accept the related cost increases. This may be particularly relevant as interest rates and the costs of houses are on the rise.
• Keeping more cash on hand: Even if you have sufficient funds to cover a large down payment, it may make sense to put down less than you can afford if you plan to make major improvements on the property or expect to need a large cash sum for some other purpose in the next few years. Sinking all of your available money into a down payment could mean savings in interest but could also require you to borrow in the future if you need cash.

Down Payment FAQs

The Bottom Line

The size of your down payment, your credit scores, and the purchase price of the home, car or loan you're financing all interact to determine how much you'll pay over the life of a loan. While saving up for a down payment, it's wise to work to build up your credit score as well. By checking your FICO^® Score from Experian for free and taking steps now to improve your credit, you can put your best foot forward when the time comes to apply for your loan.