Definition
A down payment is a partial payment that occurs at the time of purchase, with a promise to pay the remaining balance. Down payments are commonly used to reduce the amount of money borrowed on a new car or home.
Explanation
Down payments are especially important when purchasing property that will also be financed through a loan or mortgage. A down payment is usually paid directly by the person making the purchase, from funds already owned by that same individual. For example, a down payment on a car might use funds from an existing savings account at a local bank.
Typically, when purchasing a home, a down payment of 20% is required to avoid PMI, or private mortgage insurance. Down payments should not be confused with the total closing costs or money due at the time of closing, which can also include loan and attorney fees or money needed to fund an escrow account.
Lending institutions typically expect a down payment of at least 10% when financing a new car. As is the case with a mortgage, a down payment on a new home or car means the borrower has established an equity, or cash, position in the property; thereby reducing the risk of the loan.
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