- Down Payment
- A down payment is an initial payment made on an expensive good or service like a house or car. The down payment is only a percentage of the full purchase price while the remaining cost is usually paid in monthly installments.
What is a Down Payment?
When making a large purchase, such as a home or car, an initial payment is typically needed. A down payment represents a percentage of the full purchase price upfront. After the down payment is completed, the remaining balance will be paid over time.
Many homebuyers will pay a down payment of 5 to 25 percent of the total value of the home. A bank or financial institution will then cover the remaining costs through a mortgage. In addition to your down payment, you will need to present your credit score, credit history, total debt and annual income—each influences the loan amount for which you will qualify.
Why do I need a Down Payment?
There are many reasons why you might want to put a down payment down for a house or car, including:
- Lower interest rate: A substantial down payment indicates that you are a lower-risk borrower. A sizable down payment may be rewarded with lower interest rates.
- Better chance of getting approved for a loan If you don’t have a good credit score, a larger down payment can help you qualify for financing.
- Lower monthly payments: More money down means less to pay each month. It also means less interest paid over the life of the loan.
- Keep overall debt level manageable: When interest rates are high, a larger down payment will help limit the amount you spend on interest by keeping your loan as small as possible.
A down payment gives you an incentive to make your mortgage payments because you risk losing that money if you can’t make payments. This is another reason why the lender requires a down payment.
A Down Payment on a Home
The most common down payment is associated with purchasing a home. The higher your down payment, the lower your monthly payment will be. When saving for your first home, it can be stressful thinking about how much cash you will need. The FHA offers insured loans that require 3.5 percent for your down payment, but these loans require you to pay mortgage insurance for the life of the loan—your monthly payments will be higher.
Most conventional lenders offer home loans at 10 or 20 percent down payment, but other lenders might even require as little as 5 percent—it depends on the lender. A conventional loan typically requires 20 percent down to avoid Private Mortgage Insurance (PMI), which can add over $100 to your monthly payment. If the borrower puts a 20 percent down payment ($60,000 on a $300,000 home) toward a home purchase, PMI will not be required.
A Down Payment on a Car
When purchasing a car, you might need a down payment as well. Most people say a 20 percent down payment is needed for the purchase of a car—if you can afford it. If you can’t, get as close as possible—it will increase your chances of getting a loan with favorable terms, keep your monthly payments low and prevent yourself from going “upside down”, or owing more than the car is worth.
In 2014, the average new car buyer put down $3,502, which is only about 11 percent of the average new car price tag of $33,000. Used car buyers will put down even less money for their down payment, while others might not leave any down payment. You don’t necessarily need an entire down payment in cash. Two common ways to provide a down payment on a car are with a trade-in vehicle or with a cash rebate on the vehicle’s purchase.
Down Payment Financing Options
Sometimes a 20% down payment on a home can be difficult for first-time buyers or for borrowers with lower household incomes. If this is the case for you, there are some alternative programs that allow for a zero to 3.5% down payment option. However, nabbing that zero down payment might be a bit more difficult to get (one can hope, though).
The most common programs for lower down payment mortgages include:
- The Federal Housing Administration (FHA): Most FHA loans require a minimum 3.5 percent down and a good credit score to qualify. This is typically an attractive option for first time home buyers. FHA loans are federally insured, which reduces the risk of loss if a borrower defaults on their mortgage payments.
- Fannie Mae – Two additional low down payment options that allow for a 3% down payment and are not packed by the FHA:
- HomeReady mortgages Designed for creditworthy, low-to moderate-income borrowers with expanded eligibility for financing homes in low-income, minority, and disaster-impacted communities.
- Conventional 97 mortgages Designed to help creditworthy home buyers who would otherwise qualify for a mortgage, but don’t have the resources available to make a larger down payment.
And, if you meet the eligibility guidelines, you might qualify for a home loan with a zero down payment through the US Department of Veterans Affairs (VA loan) or the Department of Agriculture (USDA loan) programs. These programs have strict eligibility guidelines that must be met to qualify and can be found on their websites. State and local assistance programs are also available to help provide low down payment options.
Determining the amount of your down payment will depend on a variety of factors including the price of your home, your income and your credit score. With a good, reputable lender, you can make the best choice in a down payment for a new home or car.