By Jim AkinHow Do Down Payments Work?
Quick Answer
A down payment is money you put toward a purchase you are financing with a loan, like a house or car. It’s often required by many lenders as a sign that you're invested in repaying the debt.
A down payment is money you put toward a purchase you are financing with borrowed funds. Down payment amounts are paid upfront, and the amount is often expressed as a percentage of the purchase price.
Here's what you need to know about how down payments work, how much you need to put down on a car or home, and the pros and cons of large or small down payments.
What Is a Down Payment?
A down payment is the portion of a home, car or other financed purchase that you pay for upfront in cash. In other words, it's the part of the purchase that you don't pay for with a loan.
Putting down more money on a home or car can help you save on interest and potentially get more advantageous terms. 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.
How Do Down Payments Work?
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 (more on this below).
Tip: 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.
What Payment Methods Can Be Used for a Down Payment?
Acceptable payment methods for a down payment vary depending on the type of purchase. For example:
- Mortgage lenders typically require down payments to be made in the form of a certified or cashier's check.
- Auto loan financers may require certified or cashier's 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.
Learn more: What Can I Use for a Down Payment on a Home?
How Much Is a Down Payment for a House?
The median down payment on a house is 18% for all homebuyers, according to the National Association of Realtors (NAR). For first-time homebuyers, the median down payment is just 9%.
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.
Putting more money down on a home has significant benefits. Doing so can help you save money by paying less in interest and attain a sizable amount of home equity right away. For conventional mortgages, an important benefit to putting at least 20% down is avoiding private mortgage insurance (PMI). Because loans of more than 80% of a home's purchase price are considered riskier, lenders require PMI to protect themselves in case a borrower defaults and they must seize and resell the property.
Example: Say you're considering buying a home for $400,000. If you want to make a down payment of 20% on the home, you'd need $80,000. The result would be a mortgage equal to 80% of the purchase price, or $320,000.
While 20% or more is considered the gold standard of down payments, the good news is lenders rarely require it.
Down Payment Requirements by Loan Type
How your down payment will affect your eligibility and terms for a home loan depend on the type of mortgage you're considering. Here are the minimum down payments by loan type.
- Conventional loans: It's possible to find conventional loans with down payment requirements as low as 3%.
- FHA loans: First-time homebuyers with FICO® ScoresΘ of 580 or higher can make a down payment 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 a down payment of at least 10% of the home purchase price.
- USDA loans: You can get a USDA loan (mortgages backed by the U.S. Department of Agriculture) with no down payment requirement, meaning you won't need to put anything down. These types of loans come with specific income requirements and are available to buyers in designated rural and suburban areas.
- VA loans: 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.
Tip: Paying for PMI increases your monthly mortgage payments, but you can request PMI removal once you have 20% equity in your home. PMI cancels automatically once you reach 78% equity.
Learn more: Pros and Cons of a 20% Down Payment
How Much Is a Down Payment for a Car?
Recommended down payments for a car are typically 10% for used vehicles and 20% or more for 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.
Also, keep in mind that putting more down could lower monthly car payments.
Example: Say you want to buy a used car that costs $25,000. If you want to put 10% down, you'd be looking at a $2,500 down payment. Your loan principal would then be equal to $22,500.
Learn more: How Much Car Can I Afford?
Pros and Cons of a Larger Down Payment
Providing more than the minimum required down payment on a loan has several potential advantages.
Pros
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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.
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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.
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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.
Cons
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Could deplete your funds: If putting more down drains your available savings, it could put you in a more precarious financial situation. When you're buying a car or home, it's a good idea to set aside a portion of savings to go toward necessary maintenance and repairs. You'll also need to account for closing costs on the loan.
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Opportunity cost: In some cases, there may be better uses for the funds you'd otherwise put toward a larger down payment. For example, if you're considering buying a car and can qualify for an auto loan rate of 7%, compare that rate to the rates you're carrying on any other debts, such as credit cards. If you have balances at higher rates, making a smaller down payment on the car and applying extra funds to your high-interest debts may make more mathematical sense.
Pros and Cons 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.
Pros
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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 if interest rates and the costs of houses are on the rise.
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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.
Cons
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Increases your monthly payments: The less money you put down, the higher you can expect your monthly payments to be. You can use a mortgage calculator or car payment calculator to see how your down payment directly impacts your monthly payments.
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Increases the overall cost of the loan: A smaller down payment increases the cost of your loan in two ways. First, a smaller down payment means a higher principal balance on your loan. That means your interest rate is being applied to a larger sum of money, equaling higher interest charges overall. Second, making a smaller down payment may mean paying a higher interest rate, adding more to the total cost you'll pay.
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Increases risk: The less you put down on a loan, the closer your principal balance may be to the market value of the home or car. That could mean going underwater on your loan—in other words, having negative equity—if the value of the asset depreciates faster than you repay your balance.
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May mean paying PMI: For conventional mortgages, putting less than 20% down typically means you'll be required to pay for private mortgage insurance.
Frequently Asked Questions
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.
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About the author
Jim Akin
Jim Akin is freelance writer based in Connecticut. With experience as both a journalist and a marketing professional, his most recent focus has been in the area of consumer finance and credit scoring.
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