How Does a Downpayment Work on a Loan?

A loan down payment is a portion of the purchase price that the lender insists you pay yourself before a loan will be granted. Depending on the type of purchase you make and the purchase price, a down payment pay be a small or large portion of the purchase price.

The Basics

The total purchase price of an item such as a house or a car that you take out a loan to pay for equals the total of your down payment, the principal of the loan and the interest you pay. Since your down payment is subtracted from the principal, the larger your down payment, the less you have to borrow. Low down payments for certain purchases can cause unanticipated problems. New cars, for example, depreciate in value so quickly that with a low down payment you may find yourself owing substantially more than the book value of the car.

Private Loans

Down-payment requirements may vary greatly when you seek a loan from a private lender such as a bank. If you intend to purchase real estate, for example, private lenders typically require 20 percent of the stated purchase price. You pay the remaining 80 percent, plus interest, in installments. If you pay less than 20 percent, however, your lender typically will require you to purchase private mortgage insurance so that the lender will be reimbursed if you default on the loan. If you purchase an automobile, by contrast, you are likely to be required to pay a down payment of about 5 percent, and you may pay nothing at all.

Government Loans

Some U.S. government agencies guarantee the repayment of certain types of loans taken out by qualified borrowers, including home purchase loans and student loans. Because of the federal guarantee, down payments typically are much lower than down payments for private loans. Government agencies such as the Federal Housing Administration and the Veteran's Administration, for example, offer federally insured housing loan programs, sometimes with no down payment at all. Other agencies, such as PenFed, loan money directly to certain classes of people for other purposes, such a purchasing a car.

Down-Payment Assistance

The federal government offers qualified borrowers down-payment grants through a number of programs. Some private, nonprofit organizations also offer down payment assistance. Since these programs allow sellers to sell to buyers who would not otherwise qualify for a loan, in some cases the seller must pay a fee to participate in the program. Down-payment assistance programs are offered primarily to home buyers, because of the size of the down payment required.