A down payment is the portion of a purchase price you pay upfront in cash, reducing the amount you need to borrow. It applies to homes, cars, and other large purchases where financing is involved. The size of your down payment affects how much you borrow, what interest rate you’re offered, whether you’ll pay extra insurance fees, and how much your monthly payment will be.
How a Down Payment Works
When you buy something with a loan, the lender doesn’t cover the full price. You’re expected to bring a percentage of the cost to the table yourself. If you’re buying a $300,000 home and put down $60,000 (20%), you borrow the remaining $240,000. That $240,000 is your loan principal, and it’s what you’ll pay interest on over the life of the loan.
The down payment serves two purposes. For you, it reduces the total amount you owe and lowers your monthly payments. For the lender, it reduces risk. A borrower who has their own money invested in a purchase is less likely to walk away from the loan, and if they do, the lender has a better chance of recovering the balance by selling the asset. This is why a larger down payment often gets you better loan terms.
Down Payments on a Home
Mortgage down payments get the most attention because the dollar amounts are so large. A common benchmark is 20% of the home’s purchase price, but that’s not the minimum required. It’s simply the threshold where lenders stop requiring extra insurance (more on that below).
Conventional loans, the most common mortgage type, allow down payments as low as 3% for borrowers with solid credit. FHA loans, which are backed by the Federal Housing Administration and designed for buyers with lower credit scores, accept down payments starting at 3.5%. VA loans, available to eligible military members and veterans, and USDA loans, available for homes in qualifying rural areas, require no down payment at all.
On a $350,000 home, a 3% down payment is $10,500. A 20% down payment is $70,000. That’s a massive difference in what you need saved before closing day, but it also means the difference between borrowing $339,500 and borrowing $280,000.
Private Mortgage Insurance
If your down payment on a conventional loan is less than 20%, your lender will require private mortgage insurance, known as PMI. This is an added policy that protects the lender (not you) if you stop making payments. According to Freddie Mac, PMI typically costs between $30 and $150 per month for every $100,000 you borrow. On a $300,000 loan, that could add $90 to $450 to your monthly housing cost.
PMI isn’t permanent. Once you’ve paid down enough of the loan that you owe less than 80% of your home’s value, you can request that your lender cancel it. FHA loans have their own version of mortgage insurance with slightly different rules, and it can last the entire life of the loan depending on your initial down payment.
How Your Down Payment Affects Your Rate
A larger down payment doesn’t just shrink your loan balance. It can also lower the interest rate your lender offers. The reason comes down to a metric called loan-to-value ratio, or LTV. If you put 10% down on a $400,000 home, your LTV is 90% because you’re borrowing 90% of the property’s value. If you put 25% down, your LTV drops to 75%.
Lenders view lower LTV ratios as less risky, and they price that reduced risk into the rate. The difference might be a quarter of a percentage point or more, which over a 30-year mortgage adds up to thousands of dollars in interest. Combined with the savings from avoiding PMI, a larger down payment can meaningfully reduce the total cost of homeownership.
Down Payments on a Car
Car loans work on the same principle, but the recommended amounts differ. Financial experts generally suggest putting at least 20% down on a new car and at least 10% down on a used car.
The reason for the higher recommendation on new cars is depreciation. A new car loses roughly 20% of its value in the first year alone. If you finance 100% of a new car’s price, you could quickly owe more than the car is worth. This situation, called being “underwater” or “upside down” on a loan, becomes a real problem if you need to sell the car or if it’s totaled in an accident. Putting 20% down offsets that first-year depreciation and keeps you closer to even.
On a $35,000 new car, a 20% down payment is $7,000, leaving you with a $28,000 loan. On a $20,000 used car, 10% down is $2,000. Car dealerships will often sell vehicles with no money down, but smaller loans mean lower monthly payments, less interest paid over time, and better odds of getting approved at a competitive rate.
Where Down Payment Money Comes From
Most buyers use personal savings, but that’s not the only option. Common sources include:
- Savings accounts or investments: The most straightforward source. Lenders may ask to see bank statements proving the funds have been in your account, sometimes for 60 days or more.
- Gift funds: Many mortgage programs allow family members to give you money for a down payment. You’ll typically need a signed gift letter confirming the money is a gift, not a loan.
- Down payment assistance programs: Hundreds of programs exist at the state and local level, offering grants, forgivable loans, or shared appreciation loans to help first-time or lower-income buyers cover upfront costs. Eligibility rules vary, but many require you to be a first-time homebuyer and to fall within income limits for your area.
- Retirement account withdrawals: Some buyers tap a 401(k) or IRA for down payment funds. First-time homebuyers can withdraw up to $10,000 from a traditional IRA without paying the early withdrawal penalty, though income taxes still apply. Roth IRA contributions (not earnings) can be withdrawn at any time without penalty.
- Proceeds from selling another asset: Selling a current home, a vehicle, or other property can generate cash for a down payment on a new purchase.
Whatever the source, lenders will verify where the money came from. Large unexplained deposits in your bank account can raise red flags during the mortgage approval process, so keep documentation for any money you plan to use.
Deciding How Much to Put Down
Putting more money down saves you interest and lowers your monthly payment, but it also means tying up more cash in a single asset. The right amount depends on your financial situation, not just a rule of thumb.
If draining your savings to hit 20% down would leave you with no emergency fund, a smaller down payment might be the better move, even with the added cost of PMI. The cost of PMI on a home loan is real, but it’s often less painful than being caught with no cash reserves after closing. On the other hand, if you can comfortably put 20% or more down without gutting your savings, you’ll benefit from lower monthly payments, no mortgage insurance, and potentially a better interest rate.
For car purchases, the calculus is simpler. Cars don’t appreciate in value, so every dollar you put down is a dollar less you’re paying interest on for a depreciating asset. If you can make a meaningful down payment on a vehicle, it almost always works in your favor.
Trade-In Value as a Down Payment
When buying a car, your current vehicle’s trade-in value can serve as part or all of your down payment. If you owe nothing on your current car and the dealer offers $8,000 for it, that $8,000 is applied directly to the purchase price of the new vehicle. If you still owe money on the old car, the dealer subtracts that balance from the trade-in value, and only the remaining equity counts toward your down payment. In some cases, if you owe more than the car is worth, that negative equity gets rolled into your new loan, increasing the amount you borrow.
Earnest Money and Down Payments
In real estate, buyers sometimes confuse earnest money with a down payment. Earnest money is a smaller deposit, usually 1% to 3% of the home price, that you submit with your purchase offer to show the seller you’re serious. It’s held in escrow until closing. If the sale goes through, your earnest money is typically applied toward your down payment or closing costs. If the deal falls apart for a reason covered in your contract, you get it back. The down payment itself is the larger sum due at closing.