Loading the player...

What is a 'Down Payment'

A down payment is a type of payment made in cash during the onset of the purchase of an expensive good or service. The payment typically represents only a percentage of the full purchase price; in some cases, it is not refundable if the deal falls through. In most cases, the purchaser makes financing arrangements to the cover the remaining amount owed to the seller.

BREAKING DOWN 'Down Payment'

For example, many homebuyers pay down payments equal to 5 to 25% of the total value of the home, and a bank or other financial institution covers the remainder of the costs through a mortgage loan.

Down payments decrease the amount of interest paid over the lifetime of the loan, lower the monthly payments and provide lenders with a degree of security.

How Down Payments Affect Interest

When you make a down payment on a purchase and use a loan to pay for the remainder, you instantly reduce the amount of interest you pay over the lifetime of the loan. For example, if you borrow $100,000 on a loan with a 5% interest rate, you owe $5,000 in interest in the first year of the loan alone. However, if you have a $20,000 down payment, you only need to borrow $80,000. As a result, during the first year, your interest is only $4,000, saving you $1,000 in the first year alone.

Down payments also offer lenders a certain degree of assurance. Essentially, if a you have invested in a down payment, you may be less likely to default on the loan. Because of that assumption, mortgage lenders, in particular, may offer lower interest rates to borrowers with large down payments.

How Down Payments Affect Monthly Payments

Down payments also reduce monthly payments on installment loans. For example, imagine you buy a car for $15,000. If you take out a loan for $15,000 with a 3% interest rate and a four-year term, your monthly payments are $332. However, if you have a down payment of $3,000, you only need to borrow $12,000, and your monthly payments fall to $266. That is a savings of $66 per month or $3,168 over the 48-month life of the loan.

How Down Payments Affect Mortgage Insurance

In most cases, if you put down less than 20% when you are buying a house, you have to purchase mortgage insurance (PMI). PMI is paid to a private insurance company, and the monthly payments are called PMI premiums. If your mortgage is secured by the Federal Housing Administration (FHA), you pay for insurance through the FHA. However, if you put down a 20% down payment, you can avoid paying mortgage insurance premiums.

RELATED TERMS
  1. Private Mortgage Insurance - PMI

    A policy provided by private mortgage insurers to protect lenders ...
  2. Accelerated Amortization

    Extra payments made towards paying down a mortgage principal. ...
  3. Negative Amortization

    An increase in the principal balance of a loan caused by making ...
  4. Interest Due

    The portion of a current mortgage payment that is comprised of ...
  5. Payment Option ARM Minimum Payment

    An option to make minimum payments on an payment option ARM, ...
  6. Minimum Down Payment

    The minimum cash contribution that must be made by a borrower ...
Related Articles
  1. Personal Finance

    The Best Mortgage Deal (May Not Be What You Think)

    Don't judge a mortgage solely by payment amount. Here's what insiders know about choosing the most advantageous mortgage offer.
  2. Personal Finance

    Understanding the Mortgage Payment Structure

    We explain the calculation and payment process as well as the amortization schedule of home loans.
  3. Personal Finance

    Insuring Federal Housing Authority Mortgages

    This insurance has an edge over private mortgage insurance. Find out why.
  4. Personal Finance

    Is it Worth Saving Up for a Bigger Down Payment?

    There are numerous low-down-payment mortgage options out there, but sometimes it makes sense to build up your savings so you can borrow less.
  5. Investing

    When is a Down Payment Used?

    A down payment is an initial cash payment on an expensive good.
  6. Personal Finance

    How Interest Rates Work On A Mortgage

    A step-by-step explanation of the interest calculations, mortgage types, and how the loan is eventually "retired" – which means paid off.
  7. Investing

    Understanding The Mortgage Payment Structure

    While a mortgage’s size and term set the baseline, the interest, taxes and insurance all influence the amount of the monthly payment.
  8. Personal Finance

    Understanding Your Mortgage

    We walk through the steps needed to secure the best loan to finance the purchase of your home.
RELATED FAQS
  1. What is the difference between a PMI (primary mortgage insurance) loan and a Federal ...

    Understand the difference between a conventional mortgage that requires primary mortgage insurance and a Federal Housing ... Read Answer >>
  2. What is PMI, and does everyone need to pay it?

    Also known as "Primary Mortgage Insurance," PMI is the lenders (banks) protection in the event that you default on your primary ... Read Answer >>
  3. On average, what can I expect my private mortgage insurance (PMI) rate to be?

    Learn the several factors that come into play when insurance companies determine the private mortgage insurance rate for ... Read Answer >>
  4. Why do I need to pay private mortgage insurance (PMI)?

    The extra interest payments caused by private mortgage insurance may seem excessive, but there's a good reason lenders need ... Read Answer >>
  5. When Is Mortgage Insurance Typically Required?

    Learn about the situations in which borrowers may be required to buy private mortgage insurance, and discover who this insurance ... Read Answer >>
  6. How does the loan-to-value ratio affect my mortgage payments?

    Understand what the loan to value ratio is, how the ratio is calculated and learn how it has an impact on your mortgage payments ... Read Answer >>
Trading Center