The Importance of Your Mortgage Down Payment

A mortgage down payment is paid to the mortgage company in exchange for your loan. This sum would be forfeited if you ever defaulted on your loan and proceeded to foreclosure. While low down payment mortgages were popular in the 1990s and early 2000s, the mortgage crisis that followed led to more demanding down payments. A down payment affects your ability to achieve loan approval, the interest rate on your loan, your monthly payments and the cost of your mortgage insurance.

Loan Approval

After the credit collapse of 2007, mortgage lenders generally said goodbye to low or no down payment loans. It is common for a lender to require between 7 and 10 percent on a good credit loan and much higher on a bad credit loan. The primary exception is a loan with a guarantee. Guarantees provided by the Federal Housing Administration or a similar agency assure the lender the loan will be fulfilled, even if the individual buyer defaults. Part of the benefit of such a loan to the borrower is a lower down payment requirement. An FHA loan may be obtained with as little as 3.5 percent down. 

Interest Rate

With a private mortgage loan, the interest rate of the loan depends on three primary factors: first, the credit score of the borrower; second, the terms of the monthly payment; and third, the down payment. The down payment size works to reduce the principal sum taken from the mortgage company. Making the down payment is also an act of goodwill to the lender since it serves as collateral, in addition to the home itself, on the mortgage. All other factors being equal, a borrower who places a higher down payment on a loan will receive a better interest rate in response.

Monthly Payments

Since the down payment placed on a mortgage reduces the total sum owed, monthly payments on the sum will be lower. For example, if you purchase a $300,000 home with a 30-year mortgage and put 10 percent down, you will have to pay off $270,000 plus interest in those 30 years. However, with 20 percent down, you will have to pay off only $240,000 plus interest. The total interest on this sum is lower, and the monthly payments are lower as a result. An alternative to low monthly payments is a shorter loan. It is possible to opt for a 15-year option while keeping monthly payments low by placing down a large sum.

Mortgage Insurance

One of the key facts about down payments is often less known on the market. If you place at least 20 percent down on a mortgage, you can generally avoid private mortgage insurance. For many of the earlier years of a traditional mortgage, the lender will require you to purchase mortgage insurance to help guarantee against a default on the property. Only once you have paid down a significant amount of equity in the home will this requirement be removed. However, if you own at least 20 percent equity in the home from the start, lenders will forgo this requirement, making the cost of ownership of the home far lower.