- Down Payment
- A down payment is an initial payment made on a large purchase, often expressed as a percentage of the total cost. The down payment is paid in full up front while the remaining cost is paid in installments, often through a loan.
What is a Down Payment?
When buying a big ticket item, like a home or car, sometimes you’re required to make a large initial payment. This is called a down payment. It simply means to make a large first payment, then pay off the remaining amount over time.
A down payment will be a percentage of the total amount you owe. For instance, if you’re purchasing a home for $100,000 and the down payment is 5%, then you’ll owe $5,000 up front. You’ll pay off the remaining $95,000 through monthly mortgage payments. The amount of your payments may depend on how much of a down payment you initially made.
Down payments are commonly seen with the purchase of a home or car, or other expensive items. Your down payment may range from 3% to 20%, and there are advantages to making a larger down payment.
Lenders usually require down payments because it gives the borrower more incentive to make their payments on time. Because you’ve already invested a large amount of money, you’re more likely to continue making payments so you don’t lose the item and the money you’ve already paid.
How does it work?
People usually choose to make a down payment using their savings, or the money they have from selling a previous home. Many mortgage lenders require a minimum down payment of at least 3%. Mortgages given by the Federal Housing Administration (FHA) require a down payment of 3.5%. Your down payment may vary based on your credit history, the type of home you’re buying, and other factors, but you can expect it to be somewhere between 3%-20%.
What are the risks/benefits?
The clear benefit is that you’re beginning your loan by paying a large portion of it off. But this also means that if you stop making payments you may lose the amount you’ve already paid, as well as the item you’re paying for. If you fail to pay your mortgage your home will be foreclosed on, and if you fail to make your car payment they will repossess your vehicle.
The higher the down payment is, the lower your monthly payments may be. This is why it’s always a good idea to make the largest down payment that you can. It will lead to more manageable payments throughout the life of the loan. If you’re purchasing a home and your down payment is less than 20%, you’ll be required to purchase mortgage insurance.
Mortgage insurance ensures that your mortgage will be paid in the event of death, disability or job loss. There are two common types: Private mortgage insurance, and FHA insurance. With private mortgage insurance, you’ll be making payments to an insurance company on a regular monthly basis. They may also offer you the option of an “upfront premium” which is basically a down payment for your insurance. FHA insurance is paid to the government. With this type of insurance you’ll pay an upfront premium as well as monthly payments.2
Making a down payment of less than 20% can also lead to additional fees on top of the insurance required. This is another reason that it’s best to make a large down payment whenever possible. It will save you money and could lead to paying off the item faster than if you made a lower down payment.
- Holden, Lewis. “What a down payment on a home is, who it goes to and where it comes from.” Bankrate. March 9, 2016. Accessed May 9, 2016. https://www.bankrate.com/finance/mortgages/down-payment-1.aspx
- “Down Payment: How much you should save to buy a house” Zillow. Accessed May 9, 2016. https://www.zillow.com/mortgage-learning/down-payments/