Down Payment

Why down payments matter

A down payment serves several purposes:

• Reduces lender risk. A larger down payment means the loan-to-value (LTV) ratio is lower; if the borrower defaults, the lender is more likely to recover the full balance from the collateral.
• Demonstrates borrower commitment. "Skin in the game" — a borrower who has put their own money in is less likely to walk away.
• Reduces monthly payments. Smaller loan = smaller payments at the same rate.
• Lowers total interest paid. Smaller principal = less interest accrued over the loan's life.
• Sometimes unlocks better terms. Lenders typically offer better rates for borrowers with larger down payments.

Mortgage down payments

Standard mortgage down-payment options:

• Conventional 20% — the long-standing benchmark. Avoids private mortgage insurance (PMI), which adds 0.5-1.5% to the monthly cost when LTV exceeds 80%.
• Conventional with PMI (3-19% down) — possible with lower down payments; pay PMI until LTV reaches 80%.
• FHA loans — minimum 3.5% down with credit scores 580+. Mortgage insurance applies for the loan's life on most FHA loans (with exceptions).
• VA loans — 0% down for qualified veterans. No mortgage insurance.
• USDA rural development — 0% down for rural property purchases.

The "20% rule" is increasingly aspirational rather than typical. Most US first-time homebuyers put down less than 20%, with median down payments often in the 5-10% range.

The math: 20% vs. less

A worked comparison on a $400,000 home:

• 20% down ($80,000) — $320,000 mortgage. No PMI. At 7% over 30 years, monthly P&I: ~$2,129.
• 5% down ($20,000) — $380,000 mortgage. PMI ~$190/month until LTV hits 80%. At 7%: monthly P&I + PMI: ~$2,738.

The 20% down payer saves about $600/month, but tied up $60,000 more in upfront cash. Whether that trade-off is worth it depends on:

• Opportunity cost of the additional $60K. At 7% expected return invested, that's ~$4,200/year.
• Time to remove PMI. If the home appreciates, PMI can be removed sooner.
• How much liquidity matters. Larger down payments leave less cash buffer.

For most buyers, the right answer is somewhere in the middle — enough down to avoid the worst PMI overhead, but not so much that liquidity is dangerously low.

Down payment savings strategies

A few common approaches to building a down payment:

• Dedicated savings account — usually a high-yield savings account for the funds. Don't invest in stocks for short-horizon goals.
• Money-market funds or CDs — for slightly higher yield with comparable safety.
• 401(k) loan — borrow from yourself for down payment. Allowed but generally inadvisable; reduces retirement savings if not repaid; must be repaid quickly if you leave the job.
• Roth IRA withdrawals — contributions can be withdrawn tax-free at any time. First-time homebuyers can also withdraw up to $10K of earnings without penalty.
• Gift funds from family — often allowed for mortgage down payments with proper documentation.
• Down-payment assistance programs — state and local programs for first-time buyers, often forgivable loans or grants.

Earnest money vs. down payment

Two terms sometimes confused:

• Earnest money — small deposit (1-3% of purchase price) shown when offering on a home. Demonstrates serious intent; held in escrow; applied to the down payment at closing or refunded if the deal falls through (with caveats).
• Down payment — the larger amount paid at closing, plus closing costs.

The earnest money is typically part of the eventual down payment amount.

Beyond mortgages

The down-payment concept appears in other secured loans:

• Auto loans — typically 10-20% down, though 0% down deals exist (often at higher rates).
• Equipment financing — varies widely by industry; 10-20% common.
• Land loans — typically 20-30% down due to higher perceived risk.
• Investment property mortgages — 20-25% minimum; 30-35% for some investor loans.

In each case, the rationale is the same: lender risk reduction in exchange for capital tied up by the borrower.