How a Down Payment Impacts Your Loan
A down payment directly reduces the amount of money you borrow, known as the loan principal. A lower principal means a smaller monthly payment and less total interest paid over the life of the loan, saving you a significant amount of money.
Consider this example for a home purchase:
- Purchase Price: $400,000
- Your Down Payment (10%): $40,000
- Loan Amount (Principal): $360,000 ($400,000 – $40,000)
Your mortgage payments will be calculated based on the $360,000 loan, not the full purchase price. The $40,000 you pay upfront also establishes immediate equity—the portion of the home you own outright.
How Much Should You Put Down?
The required down payment depends on the type of purchase and loan. While the traditional 20% rule for homes is well-known, many options exist for creditworthy borrowers.
For a Home Mortgage
Putting down 20% on a conventional home loan helps you avoid Private Mortgage Insurance (PMI), an extra fee that protects the lender if you default on your loan. However, several government-backed and conventional loan programs offer lower down payment options.
| Loan Type | Minimum Down Payment | Primary Borrower |
|---|---|---|
| Conventional Loan | 3%–5% | Borrowers with good credit (typically 620+) |
| FHA Loan | 3.5% | Borrowers with lower credit scores (down to 580) |
| VA Loan | 0% | Eligible veterans, service members, and surviving spouses |
| USDA Loan | 0% | Buyers in eligible rural areas with low-to-moderate income |
For a Car Loan
While not always required, a down payment on a car loan is highly recommended. Cars depreciate quickly, and making a down payment of at least 10–20% can prevent you from becoming “upside-down”—owing more on the loan than the car is worth.
Frequently Asked Questions (FAQs)
- What’s the difference between a down payment and closing costs?
- A down payment reduces your loan principal. Closing costs are separate fees paid to lenders, title companies, and other parties to finalize the transaction. They typically range from 2% to 5% of the loan amount.
- Does a larger down payment improve my credit score?
- Not directly. The size of your down payment isn’t reported to credit bureaus. However, by reducing your loan amount, it lowers your debt-to-income (DTI) ratio, which is a critical factor lenders use to assess your application.
- Can I use gift money for a down payment?
- Yes, most lenders allow you to use money from a close relative. You will typically need to provide a formal gift letter confirming the funds are a gift and not a loan that must be repaid. For more information, the Consumer Financial Protection Bureau (CFPB) offers guidance on preparing for these costs.