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The amount of your down payment on an installment loan affects your loan amount as well as how much you pay each month. A higher down payment shrinks your loan balance upfront, which means you'll pay less each month. The opposite is true, too, as a lower monthly payment increases your monthly payments.
What Are Down Payments and How Do They Work?
A down payment is a lump sum of money you give a lender upfront when you're financing a large purchase, such as a home or car. It's typically expressed as a percentage of the total purchase price. For example, if you're buying a home that costs $300,000 and your lender asks you to put 10% down, the down payment would be $30,000.
Lenders require down payments as a way to reduce risk as it means the borrower has
skin in the game from the get-go. They know borrowers are less likely to stop making payments if default means saying goodbye to a potentially significant down payment. Larger down payments reduce the loan amount, which also reduces the risk the loan presents to lenders.
Here's how down payments work at a basic level: Lenders set the minimum down payment requirements for the loans they offer, though borrowers have the option to put down more. When the loan closes, you'll submit your down payment and the lender subtracts the amount from your loan amount. You'll then pay the remaining amount by making installment payments over time.
How Does a Down Payment Affect My Monthly Loan Payment?
Here's how your down payment affects your monthly payments when taking out a loan:
- Reduces the amount of your loan: Making a down payment essentially means you're paying some of the loan upfront, so it shrinks your starting loan balance. With a larger down payment, your monthly payments drop accordingly because the size of the loan is smaller. How much you save each month depends on the amount you put down; generally, the larger your down payment is, the lower your monthly payments will be.
- Can lower your interest rate: A larger down payment gives you more stake in your property, which lowers risk for the lender. In turn, the lender may offer you a lower interest rate. All else remaining equal, a lower interest rate means a lower monthly payment.
- Lowers your overall interest costs: When you lower both your interest rate and your monthly payments, the combined effect is a reduced interest cost over the life of the loan. You can get interest rate quotes from lenders and use a mortgage calculator to compare savings between different down payment sizes.
- Allows you to avoid mortgage insurance: Lenders often require mortgage insurance when you put down less than 20% as a way to protect themselves from financial loss in the event you default on the home loan. Mortgage insurance can add several hundred dollars to your mortgage payment. With a down payment of at least 20%, you can avoid mortgage insurance altogether and lower your monthly payments.
Down Payment Example
Let's say you want to take out a 30-year conventional mortgage for $300,000 with an interest rate of 6%. You can use a mortgage calculator to compare the potential costs based on two different down payments.
A down payment of 5% costs $15,000 upfront and results in a monthly payment amount of $1,709. Increasing the down payment to 20% results in a higher upfront cost of $60,000, but your monthly loan payments drop to $1,439. Over the life of the loan, making the larger down payment would help you save $97,200 in interest costs.
You may save even more if the larger down payment lowers your interest rate and helps you avoid PMI payments. To better estimate your savings, ask your lender to calculate your interest and PMI costs on several down payment options.
|5% Down Payment||20% Down Payment|
|Monthly principal and interest payment||$1,709||$1,439|
|Savings over life of loan|
How Much Do I Need for a Down Payment?
Your down payment will depend on factors like the type of mortgage you're getting, how much you can afford and the lender's requirements. Generally, putting down more cash results in a lower monthly payment because you're borrowing less and you may qualify for a lower interest rate.
However, saving for a 20% down payment is often challenging for homebuyers. The average buyer made a 13% down payment on a primary residence in early 2023, according to Realtor.com. You'll have to weigh the pros and cons of making a large down payment before making your decision.
Pros and Cons of a Large Down Payment
- Lowers your monthly payments: You'll borrow less when you pay more of the loan upfront, so your monthly payments decrease.
- Typically helps you get a lower interest rate: Lenders may lower the rate because they take on less risk when you pay more upfront.
- Potentially helps you avoid mortgage insurance: You won't have to pay for mortgage insurance if you put down at least 20%.
- Increases your home equity: Your down payment immediately gives you equity in your home, which can help you avoid going underwater on your loan and is available to borrow against later.
- Costs more upfront: The larger your down payment, the more you have to save. This may push out your home purchase timeline.
- Depletes your savings: Spending more on a down payment means you're putting less money toward your savings accounts or other financial goals, such as retirement.
What if I Can't Afford a Large Down Payment?
A lower down payment will impact your payments as well as your ability to qualify for a loan. However, for a mortgage, you may be able to take advantage of government programs and special lender offerings that have looser requirements. Here are the minimum down payments for each program:
- Federal Housing Administration (FHA) loans: A borrower with a credit score of 580 or higher can make a down payment of 3.5%. If the borrower can come up with a down payment of 10%, they may qualify with a credit score as low as 500. FHA loans do require mortgage insurance with a down payment of less than 20%, however, and you may have to refinance the loan to remove it.
- Department of Veterans Affairs (VA) loans: These loans are designed for eligible service members, veterans and surviving spouses. Most homebuyers won't need to make a down payment, but they'll need to cover a funding fee that ranges between 1.25% and 3.3% of the loan amount. Each lender sets its own credit score minimum. VA loans do not require mortgage insurance.
- U.S. Department of Agriculture (USDA) loans: USDA loans also require no down payment or mortgage insurance. But you'll need to buy a home in an eligible rural area and meet income restrictions that are specific to your area.
If government-backed home loans aren't a great fit for you, then you've still got options. Some lenders offer their own home loan programs that come with low down payments and no mortgage insurance. However, you may pay a higher interest rate with these loans. Shop around with several lenders to compare your options.
Down payment assistance programs may also help you cover your upfront homebuying costs. Each program has different offerings. Some provide grants that cover your down payment and closing costs, while others provide low-cost loans with flexible payback features. To qualify for down payment assistance, you may need to be a first-time homeowner and meet other requirements, such as income limits.
The Bottom Line
The size of your down payment can influence how much you pay your lender each month and over the life of a loan. Making a larger down payment can help you save money, but you'll need to figure out how much you can afford to put down. While you're planning your purchase, it's also a good idea to review your credit. By checking your FICO® Score☉ from Experian for free and taking steps to improve your credit, you can improve your chances of qualifying for a mortgage and getting a good interest rate.