What Is a Down Payment? [Definition, Tips, and Examples]

How do you pay for big-ticket items like a house or a car? Most individuals would make a down payment to acquire those assets faster. But what is a down payment?

In this article, we will:

  • answer that question and help you understand how it works
  • explain the advantages of making higher or lower down payments
  • show you what you can do to fund the down payment and the loan itself.
  • discuss the government programs that help you make down payments

Read on!

What Is a Down Payment?

A down payment is what you pay at the beginning of an expensive purchase, and it’s often in cash. This type of payment is a percentage of the full price. In other words, if you cannot make the purchase in one full payment, you can arrange to make a down payment first and then make regular payments afterward until the full price is paid.

Most of the time, the down payment is non-refundable, especially if the purchase falls through because of the buyer.

This down payment definition applies in the case of large purchases, such as a house or a car. You pay a percentage of the overall price and get a loan to cover the rest of it. The down payment gives the lender a certain degree of assurance. If you have made the down payment, then you are less likely to default on the loan.

As a result, lenders are also more likely to give you lower interest rates if you start the purchase with a large down payment.

How Do Down Payments Work?

If you decide to make a large purchase, e.g. a house or car, you can make a down payment and get a bank to pay the rest as a mortgage or auto loan, respectively. Down payments help you lower the overall interest rate you’ll pay throughout the loan’s life span.

The down payment amount will ultimately depend on the lender, but the following offers an overview of how much you can expect to pay.

Buying a Home

House purchases are among the most expensive purchases many people make. But what is the average down payment on a house? In the US, the average amount is equal to around 6% of the total loan value.

You may get a lower rate depending on the type of loan and your credit score. Typically, the better your credit score is, the lower the down payment you need to make.

However, other home buyers may be compelled to put down as much as 20% to avail themselves of even lower rates. There are a few other benefits to making bigger down payments, which we’ll tackle later.

Buying a Car

Auto purchases are another major expense for the average buyer, and down payments make owning a car easier for many. So, what is a good down payment for a car? The average car down payment is around 11.7% both for new and used car purchases.

Lenders, however, continue to insist that a 20% down payment is much better for the borrowers. The same reasoning applies: you’ll get lower rates and make smaller monthly payments. At the same time, making a huge down payment gets you approved faster for a car loan.

Down Payments Requirements

If you’re a low-to-moderate income borrower, you can apply for different home loan programs that provide benefits and discounts. Here are some of them:

  • FHA Loan

 The Federal Housing Administration (FHA) loan program lets you borrow as much as 96.5% of the value of a home purchase. You’ll only have to make a 3.5% home down payment to acquire a house. To be eligible, your credit history must be good, and your credit score must be at least 580. If it’s between 500 and 579, you can still qualify if you can make a 10% down payment. You also need to buy a mortgage insurance premium, and you must have a steady source of income and provide proof of employment.

  • VA Loan

If you’re a veteran, what is a good down payment program for a house? A VA loan is the answer. This loan is a $0 down payment mortgage option from private lenders, and it’s partially backed by the Department of Veterans Affairs. To be eligible, you need to have served for 90 consecutive days of active service during wartime or 181 days during peacetime. You may also qualify if you’ve served 6 years in the National Guard or the Reserves, or if you’re a spouse of a member of the military who died in the line of duty.

  • USDA Loan

Making a home down payment may be difficult if you’re not wealthy and can’t get a traditional mortgage. In this case, a USDA loan is more appropriate. This is a $0 down payment mortgage for rural homebuyers. It can be in the form of loan guarantees, direct loans, or home improvement grants. The main down payment requirement is a monthly payment that’s 29% or less of your monthly income. You must also have acceptable credit records and a credit score of 640 or higher.

Advantages of Higher Down Payments

Does a large down payment help you? The quick answer is yes, and it provides many solid benefits you can enjoy, including:

  • Lower interest rates: making a huge down payment means you’re borrowing a lower amount of money from the lender, which also means you’ll pay lower interest rates overall. Lenders are also more willing to offer lower loan rates since they know you’ve already invested a big amount of money in the purchase.
  • Smaller monthly payments: not only does a significant down payment affect the interest rate, but it also affects the monthly payments you make. That’s because you’ve borrowed a smaller amount of money overall.
  • Mortgage Insurance: if you pay at least 20% of the total price, you don’t have to pay for private mortgage insurance, which can add thousands of dollars per year to your housing costs. This is meant to protect the lender in the event of default.

Smaller Down Payments

What does a small down payment mean relative to house or car purchase? It’s any down payment that’s below 20% of the total cost. Smaller down payments come with the following benefits:

  • Protect your savings: making a huge down payment may deplete your savings. If you can afford the relatively high monthly payments, then making a smaller down payment helps protect your savings.
  • Flexibility in expenses: making a smaller down payment makes sense if you need a bigger cash reserve for other important expenses such as paying for medical bills, vacations, and other items.
  • Faster process: the smaller amount, the faster you can make the down payment deposit. This results in faster processing of your purchase.

Obtaining Money For a Mortgage

Securing the down payment money for a mortgage may be tough especially for low-to-moderate-income individuals, and those with bad credit. However, here are some ways you can do this.

  • Savings: most borrowers tap into their savings to finance mortgages and big-ticket purchases.
  • Selling expensive items: if you have expensive things that you can do without, it’s probably better to sell them and use the money to make the down payment and pay off the mortgage.
  • Gift: you can also get gift funds from a friend or family member, but you’ll need a gift letter that confirms your relationship with the giver. It should also indicate that no repayment is expected.
  • Down payment assistance programs: what is the purpose of a down payment assistance program? As the name suggests, it’s meant to help you make a down payment easier. These programs include FHA, VA, and USDA loans that lower the amount of the required down payment.
  • 401(K) Retirement Plan: you can also borrow from your 401(K) fund and use the money to pay for the car or mortgage loan. Although the amount you can borrow may be limited, you’ll be able to make the down payment fast, plus it doesn’t incur any income taxes or tax penalties.

Wrap Up

A down payment is an initial payment for a high-priced purchase before making regular payments until the loan is completely repaid.

Down payments are often made by people buying a house or a car. So, how much is a down payment on a house or a car? The answer generally depends on the lender, but it’s great if you can make higher down payments — at least 20% of the total purchase amount — so that you can benefit from lower interest rates, lower monthly payments, and the absence of insurance premiums.

FAQ

What is a down payment, with an example?

A down payment helps you acquire the big-ticket item you want to buy after making an initial deposit. For instance, if you want to buy a house or a car, you can pay 20% of its total price and make monthly payments afterward and until the full cost is covered.

How does a down payment work?

A down payment works by letting you pay a certain amount of money to acquire property before even paying it in full. Generally, making a higher down payment means lower overall interest rates and monthly payments. This also helps you avoid paying high private insurance premiums.

How much should I pay for a down payment?

You should pay 20% of the total cost of the purchase as a down payment. What is a down payment of 20% going to do to help you? It will help you save money in the long haul by helping you lower the actual amount you’re borrowing from the lender.

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