Down Payments Explained (How Much Should You Pay?)

Preparing for a big-ticket purchase? Be sure to learn about down payments beforehand. It’s pretty rare to buy a house, car, wedding ring, or any type of expensive item in all-cash without draining your savings, so many people turn to financing to seal the deal. But you’ll still need some upfront cash to place a partial payment that lets your lender know you’ve got skin in the game.

Most financing terms require a down payment to secure the loan—but what is a down payment, how do they work, and how much should you save up for? We’ll cover all of that and more in our down payment guide, or you can jump ahead to the section that sparks your interest by using the links below.

• What is a down payment?
• Types of down payments
• How down payments work
• Lender requirements
• How much should you put down?
• Benefits of a larger down payment vs smaller down payment
• How to to save for a down payment

What is a down payment?

Let’s start with a simple down payment definition: A down payment refers to the portion of cash paid upfront when financing an expensive purchase, like a house or car.

Think of a down payment as the portion of the price you pay for out-of-pocket (as opposed to borrowing), expressed as a percentage. When you’re buying a pricey item with a loan, an initial payment is usually required; how much you put down can be critical to getting approved, and the amount you pay upfront can also significantly impact your overall borrowing costs throughout the lifespan of the loan.

Types of down payments

There are many different types of down payments, all with their own varying terms and structures. We’ll take a look at some of the most common ones below.

• Down Payment on a House

When you’re ready to buy a house, you’ll need to apply for financing through a mortgage lender. A mortgage down payment represents your contribution to the purchase and initial ownership stake in the home. The lender then covers the remainder of the price to complete the sale.

While most lenders require a mortgage down payment, there are certain exceptions to this rule. If you qualify for a VA loan or USDA loan, which are backed by the federal government, there may be no minimum down payment required.

• Down Payment on a Car

Buying a new car is exciting, but also expensive. If you can’t afford a new set of wheels outright, then you may be able to qualify for financing with a down payment on a car that applies toward its principal balance. In some cases, you may be able to find a vehicle offered with “zero-down”, meaning that financing is available with no minimum down payment.

Note: Even though you might not have to make a down payment on a house or car, doing so anyway could be well within your interest—we’ll dive deeper into those details in a bit.

• Other Assets

There are all sorts of items you can buy with a down payment loan, from boats to dirtbikes, memory foam mattresses to full furniture sets, diamond rings, shiny things—even music festival passes can be purchased with money down upfront and paid off in installments on little to no interest.

How down payments work

Put simply, down payments reduce the amount of money you’ll have to borrow in order to purchase a home, car, or similar expense. The higher down payment percentage you pay, the less financing you’ll need to cover the remainder of the purchase price. And the smaller the loan you take out, the faster you can get out of debt, usually with less interest accumulated.

Lenders want to make borrowing decisions they feel confident about and a large down payment suggests that you’re invested in the transaction. You won’t be seeing that money back, so contributing a sizable amount of your personal savings shows that it’s in your interest to pay off the loan with timely installments to minimize the risk of default and losing the money you’ve put at stake.

Note: This is why down payments are sometimes known as “deposits”, especially in England where deposit mortgages are very common.

• Home purchases

Let’s look at an example:

A 10% down payment on a house that costs $300,000 would be $30,000. The lender finances the remaining $270,000, which you can repay over the course of a 15- or 30-year mortgage loan (on top of interest and closing fees) with monthly installments—unless you pay it off early with one large payment or choose to refinance the mortgage down the road.

• Auto purchases

A 20% down payment on a car that costs $20,000 would be $4,000. You bring the cash or cashier’s check to the dealership and agree to cover the remainder of the sticker price through financing. The most common term on an auto loan is 72 months, but the shorter the loan length, the quicker you can build equity in your vehicle. You can also refinance a car loan similar to a home mortgage, but the qualification criteria weighs more heavily on the borrower’s credit score rather than the outstanding loan balance and market value.

Lender requirements

Minimum down payment requirements vary by lender and the borrower’s credit score. For example, you can qualify for an FHA loan with a down payment as little as 3.5% if your credit score is 580 or higher, but if your credit score is between 500 and 579, you’ll need to put down at least 10%.

When it comes to conventional mortgages, lenders require borrowers to pay Private Mortgage Insurance (PMI) to protect them from the risk of default. This can dramatically increase the overall borrowing cost of your loan, typically ranging around 0.3% to 1.2% of the principal balance per year.

However, a mortgage down payment of 20% waives the PMI requirement and can thereby save you a significant amount of money by eliminating the insurance premiums on top of your monthly payments.

How much should you put down?

While many individuals aim to place a 20% down payment on a home in order to avoid PMI, this isn’t always attainable—especially for first-time homebuyers looking to enter the real estate market. Learning how to save for a house is no easy task, and amassing savings worth tens of thousands of dollars can be really challenging while paying off student loan debt and keeping up with the costs of living.

New research from the National Association of Realtors reports that 61% of first-time buyers put down between 0% and 6% in order to make purchasing a home more affordable. So, although 20% down is a good rule of thumb, it’s certainly not a hard requirement. You might also consider taking the time to improve your credit score in order to qualify for a mortgage at a better rate with a smaller minimum down payment requirement.

When it comes to how much you should put down on a car payment, Autotrader.com also advises 20% of the purchase price in order to avoid becoming “upside-down” on your car loan, or owing more than the car is worth. New vehicles tend to depreciate at a fast rate; you might find yourself in a position where you get in an accident, total the car, and receive a check from the insurance company for the car’s value, only to find that the amount is much smaller than the loan you’re still paying off.

A larger down payment percentage can help offset the depreciation hit, and it also means that your lender won’t have to sell the car at top dollar should they have to repossess your vehicle—meaning you may be able to negotiate a better interest rate on the car loan. It’ll also lower your monthly payment which can help you afford a shorter term so you can own the car sooner and pay less in interest, no matter what rate you negotiated.

Benefits of a larger down payment vs smaller down payment

There are several pros and cons to putting down more money versus less money. ConsumerFinance.gov offers advice on how to decide how much to spend on a down payment, but here are some benefits to each side of the coin you may want to consider. 

On the one hand, a higher down payment can earn you a lower interest rate and therefore a lower monthly payment. It’ll also reduce or eliminate PMI premiums, potentially saving you thousands of dollars in the end.

On the other hand, a lower down payment will allow you to purchase a home or car sooner. You’ll also be able to keep some funds aside for renovations or repairs and maintain savings in your emergency budget.

How to save for a down payment

Ready to start shopping? Here are some tips on how to save for a down payment to improve your chances of receiving great financing terms:

• Set savings goals – You should first calculate roughly how much you’ll need to set aside and how long it’ll take you to do so. Chipping away at a timeline can help you stay on track and achieve your savings goals.
  
• Cut expenses – Tighten your budget by eating in more often or canceling your streaming subscriptions and allocate that money toward a down payment so you can hit your savings goals faster.
  
• Increase income – You might consider taking up a side hustle to bring in a little more money and buy a home or car sooner rather than later.

Mint can help you manage your budget and bolster your savings so you can afford a car or mortgage down payment on a realistic timeline. Download the app today to get started.