Down payment is the money, usually cash, that purchasers pay in early stage as a part of their large purchase. In England, it is also known as deposit. Generally, purchasers need to make down payment when they try to buy expensive items such as house or car.
Sellers may require a down payment that costs a certain percentage of the total principal and the required amount is based on purchasers’ credit rating, financial status and the purchase they make. Although down payment can be different among different purchasers, ranging from 3.5% to 50% of the total loan, one thing is certain. The higher the down payment is, the lower the interest rate is if purchasers need to apply for a mortgage loan later.
How does it work?
Down payment is a useful tool for purchasers to get loans and lower future interest rate and the monthly payment.
It is usually applied to home purchases and auto purchases. If the sellers do not require a down payment, it is very likely for lenders to charge a higher interest rate. On the contrary, if purchasers have made a large down payment, they can enjoy a much lower interest rate and they do not need to pay mortgage insurance premiums since the lenders assume that they would not default on the loan. For the ones that wish to purchases a house with a down payment that is less than 3.5% of the principal, they have to choose Federal Housing Administration (FHA) loan.
Down payment is also very useful to lower the interest and monthly payment since it will be deducted from the total principal in advance. For example, if someone borrows a loan of $500,000 with a 5% annual interest rate, he has to pay $25,000 per year. In this case, if the purchaser makes a down payment and pays $100,000 at first, the total borrowed money is $400,000 and the required interest for the first year is 20,000. Also, with the deduction of down payment, the purchaser is able to reduce their monthly payment.