What is a down payment?
A down payment is simply a large sum of cash paid upfront on a larger purchase, where the remaining cost will be financed.
What can I use a down payment on?
There are two typical purchases where a down payment is usually found: the purchase of a home and the purchase of a car.
A down payment is extremely helpful when purchasing a home and is often a necessity with mortgage lenders.
When buying a car, a down payment is not seen as being as important to purchasing the car as a home. While many lenders will not consider working with you if you have a zero-down payment for a house, car dealers are much more likely to offer financing options and work with you and your financial situation.
How much is a down payment?
Depending on the item purchased, the buyers’ income level, and the buyers’ credit history, the amount for a down payment can vary greatly.
A down payment on a car purchase can vary greatly. In order to gain your business, car dealers may run promotions such as 0% down. Purchasing a new car typically will come with a required higher down payment such as 20% down.
The lowest most mortgage lenders will allow is a 3% down payment on a home using a conventional loan. In order to qualify for this loan, however, you will probably need a good credit score over 640. Also, you may need to prove you can afford, based on your income, the monthly payment of the remaining, financed mortgage.
Often purchasing a new home is coupled with a 20% down payment. The reason for that is not being it is required but rather because it provides a lot of benefits as seen below. Because of the benefits, 20% down on a car or home purchase is a good standard to aim for.
What is the benefit of using a down payment?
Not all down payments are created equal. A 3% down payment on a home will not afford you the same benefits as a 20% down payment. Below are three benefits of a down payment, with each being more beneficial the higher the down payment.
• Lower Interest
Interest is affected in two different ways depending on the size of your down payment.
First, the more you put down, the less you need to finance and a smaller amount will be affected by interest. If you purchase a $100,000 home with 3% down you are financing $97,000. In comparison, if you buy the same home with 20% down, you are only financing $80,000.
Assuming you have the same interest rate for 3% down as you do for 20% down, your payment will be less with 20% simply because of the amount being financed.
Here is a quick example. A 30-year mortgage at 5% interest for $100,000 would cost $93,256 in interest alone. In comparison, $80,000 at the length and interest rate costs $74,605. That is a difference of almost $20,000.
Second, a higher down payment may lower your interest rate. The interest rate on a $100,000 dollar house may be lower if you are able to put 20% down rather than 3%.
• Lower Monthly Payments
This second benefit is directly connected to the first in how it saves you money.
Using the illustration above, a $100,000 loan has a monthly payment of $537 where an $80,000 loan comes to $429.
• Avoiding PMI on a Home Purchase
PMI, or Private Mortgage Insurance, is the final benefit. Generally, to avoid this additional cost lenders will require you to put 20% down. If you cannot afford 20% as a down payment, you can normally ask your lender, once your equity in the home reaches 20%, to drop this cost.