Understanding Down Payments and Their Impact on Your Next Big Purchase
- Author: Noah Koch
- Posted: 2024-06-05
Types of Down Payments
Down payments can last for years in two main types: home and car purchases. The down payment size varies from lender to lender, agreement to agreement, and from one kind of purchase to another. For home purchases, the down payment tends to be smaller than car purchases because cars depreciate more quickly than homes.
1. Home Purchases
A home purchase's down payment size can vary depending on the purchase price and the buyer's creditworthiness. The size of the down payment determines how much of the purchase price needs to be financed by the seller. Homeowners should decide on their down payment after figuring in their closing costs, which is about 3% of the home's purchase price.
2. Auto Purchases
Getting approved for an auto loan or buying a car is much more of a financial decision than purchasing a home. Several factors influence the need for a down payment in auto purchases. These factors include the type of loan, the amount borrowed, and the time between paying off portions of the loan. Due to promotional terms by car dealerships and financing firms, the time it takes to pay off a car loan must be considered when determining a down payment and lending terms. A car's estimated annual depreciation costs may also influence the need for a down payment.
Benefits of a Large Down Payment
Making a large down payment has both financial and practical benefits. A sizeable down payment decreases the interest paid on a loan over time. If a home buyer decides to put 20% down on their mortgage, they will eventually be charged less interest than someone who puts only 3% down. In car purchases, the larger down payment decreases the time it takes to pay off the loan.
Installments on home and car purchases are related to the down payment that is made. The larger the down payment, the smaller the monthly payments will be. When making a purchase, a good rule of thumb is to set aside one-third of your income for housing, including your mortgage payment, property taxes, and homeowner's insurance. If you choose to make a sizeable down payment on your car instead of a large down payment on your home, you should plan on spending slightly more each month.
Lenders need private mortgage insurance (PMI) if the down payment on a home is less than 20%. By paying PMI, borrowers are required to make monthly payments to the lender instead of paying interest on the loan. However, PMI can be expensive and cause problems for some buyers. Even though it is optional, choosing to pay for PMI is usually a good idea to take advantage of mortgage interest rates and lower monthly payments.
Lower Your Personal Debt to Save for a Good Down Payment
Getting the most out of your down payment requires planning and sacrifices. When it comes to paying off other debts, make your monthly payments with the highest interest rate first so that you can pay off smaller loans quicker.
Get preapproved for Your Loan
Pre-approval comes in two forms - formal pre-approval and informal pre-approval. A formal pre-approval is a letter that confirms that an institution, such as a bank or financial institution, will make your loan available. An informal pre-approval is verbal communication with an agent or lender regarding funding for a mortgage loan.
Generally, the larger the down payment, the better because it can reduce monthly payments, making the debt easier to repay. Usually paid in a lump sum, the down payment can be spread over several installments. The seller will receive the down payment and then distribute the remaining money to cover the remaining cost.
