What is a down payment?
A down payment is an upfront payment of a portion of the total price of a big-ticket item such as a home or a car. A down payment reduces the amount of the purchase price that needs to be financed, and helps the seller share the risk of non-payment with the buyer.
A down payment is usually a percentage of the total purchase price. The amount required for the down payment is based on several factors, although the amount is most commonly dictated by the seller. The typical down payment on a house is usually 20 percent, although it can range from 3.5 percent to 25 percent.
Down payments offer advantages to both buyers and sellers. By reducing the amount that needs to be borrowed, a down payment lowers a buyer’s monthly payments and reduces interest charges. A down payment demonstrates the buyer’s commitment to the purchase and decreases risk for the seller. A seller might be more likely to accept an offer from a buyer with a large down payment.
Lenders usually offer lower interest rates with a sizable payment upfront. A homebuyer who pays less than 20 percent down is usually required to buy private mortgage insurance (PMI), which is added to the monthly mortgage payment.
Some mortgage programs offer low down-payment options. FHA loans, for example, require a down payment of just 3.5 percent to 5 percent. One of the most attractive features of VA home loans is that they can be obtained with no down payment.
Down payments are also common in vehicle leases. But plunking down a lot of money upfront isn’t necessarily the best move with a car lease. Vehicles depreciate so quickly that the customer could end up investing too much and not getting an adequate return on the money put down.
How much of a down payment should you make on a purchase? Use our down payment calculator to find out.
Down payment example
A couple who’ve been saving for a home purchase one for $200,000. To avoid having to buy private mortgage insurance, they put down 20 percent, or $40,000, toward the price. They decide to roll the $2,000 in closing costs into their loan, giving them a total amount financed of $162,000.
Their interest rate is 4.04 percent. They get a conventional 30-year mortgage, with fixed monthly mortgage payments of $777.15. Without the 20 percent down, their monthly payment would be much higher because they would have to pay for PMI and their interest rate would probably be higher.