A down payment is the portion of cash you must pay up front on a purchase that is primarily funded by a loan. Most lenders require down payments as a condition for approval on large loans. We looked at the different rules concerning down payments and how the size of your down payment affects the total cost of your loan.
- What is a Down Payment?
- Down Payment For a House
- Down Payment to Finance a Car
- Commercial Real Estate Down Payments
Down Payments Explained
A down payment is the initial cash that goes towards any purchase paid for with a loan. For mortgages and car loans, consumers usually pay 3% to 20% of the asset's cost with their own cash and borrow the rest of the purchase amount. The following is a typical example of a car purchase financed with a down payment and installment loan, a type of loan paid off over time.
|Car Purchase Price||$25,000|
|Down Payment||$7,500 (30%)|
|Loan Repayment Term||60 months|
|Interest Rate (APR)||5%|
Loan-to-Value Ratio: Down payment minimums are commonly expressed as the loan-to-value (LTV) ratio. The LTV is a percentage that describes how much of a particular asset is financed by a loan. This figure is calculated by subtracting the down payment from the asset's total cost. For example, if you put down 20% on your house, the loan-to-value ratio of your mortgage would be 80%. LTV requirements differ by loan type, with larger loans generally requiring lower loan-to-value ratios. This means that more cash must be paid up-front.
|Loan||Typical Loan-to-Value Ratio||Typical Down Payment|
|30 Year Conventional Mortgage||80% - 97%||3% - 20%|
|Commercial Real Estate||50% - 90%||10% - 50%|
Equity: Your equity in a piece of property is the dollar value of the ownership stake you hold. When you purchase something with a loan, your equity is equal to the total amount you have paid so far. For example, if you make a 30% down payment on a piece of commercial real estate worth $1,000,000, you have $300,000 in equity. Your equity will grow as you make more monthly loan payments.
For home loans, your initial equity determines the amount of mortgage insurance you have to pay. If you make a down payment greater than 20%, no private mortgage insurance is required. With mortgage down payments lower than 20% of the home's value, you have to pay for mortgage insurance until your payments reach the 20% equity mark — in other words, when your loan-to-value ratio is less than 80%.
Down Payment for a House
Mortgage down payments typically range from 3% to 20% of home value. In general, making a larger mortgage down payment will reduce your long term costs; a smaller loan size means lower monthly bills and interest payments and no mortgage insurance costs for down payments of at least 20%.
Down payment minimums differ for the three main types of mortgages: conventional loans, FHA mortgages and VA mortgages. The government has set the legal minimum mortgage down payment at 3% for conventional loans, with specific requirements varying based on loan size, lender and credit score. Favored by low credit consumers, FHA loans have a minimum down payment of 3.5%, but require mortgage insurance payments for the life of the loan. Through VA loans, 0% down payment mortgages are available for veterans and their spouses.
Down Payment to Finance a Car
The down payment required on a car loan mostly depends on your credit score. Car buyers with excellent credit profiles may even find financing that requires "zero down," although the precise terms can vary. With so many prospective borrowers, auto financing companies provide a wide range of loan options at every credit level. However, cars depreciate quickly, making high-balance, long-term car loans potentially dangerous. Putting no money down up front can inflate your total debt, leading to a situation in which you owe more than your car is worth.
Before buying, you should determine how large of a down payment and monthly bill you can afford, while also considering the financial effects of depreciation and interest. If you don't plan on owning your vehicle in the long term, you might also consider a lease as another short-term financing option. In a lease, you simply pay to use the car for a set term, after which you either return the vehicle or pay the remaining sum required to purchase it outright. This can protect you from the usual effects of depreciation, although not owning the car means following the dealer's rules on how far you drive and how you maintain the car.
Commercial Real Estate Down Payments
Commercial real estate loans have down payment requirements that vary from 10% to 50%, depending on the loan type and use of the property. For investment property purchases, down payment requirements range from 25% to 40%. If you plan to occupy the building yourself as a headquarters or primary place of business, you can likely qualify for a lower down payment, around 10% to 20%.
|Loan||Typical Down Payment|
|SBA 504 Loan||10% - 20%|
|SBA 7(a) Loan||10% - 20%|
|USDA Business & Industry Loan||20% - 25%|
|Traditional Bank Loan||20% - 30%|
|Online Loan||10% - 30%|
|Bridge Loan||10% - 20%|
|Soft Money Loan||35% - 40%|
|Hard Money Loan||45% - 50%|
Your required down payment will also be determined by the type of loan for which your business is qualified. Government-backed SBA 504 loans allow for relatively low down payments, while commercial real estate loans that are risky for the lender —like bridge loans and hard-money loans —have much higher down payment requirements. If you're a small business owner, you should think about what type of commercial real estate loan best fits your needs, and then calculate your down payment based on that loan's requirements.