What is a Down Payment? Here Are Some Points You Need to Know

When you buy a high-priced item by taking a loan, you must put down a certain proportion of the purchase price. The payment that you make is crucial in deciding your loan terms, interest rate, and tenure. Therefore, it is crucial to understand how a down payment works. 
 

Things to Know About Down Payment

 

What is a Down Payment?

Down payment refers to an upfront payment that you make to acquire a vehicle, consumer durable goods, or real estate property. You can make a down payment in cash, cheque, or using another financing product such as a credit card or funds from a personal loan. The amount of the down payment varies depending on the loan type and the borrower's profile. The down payment might be anywhere from 5% to 25% of the purchase price.
 
Now that you have a better understanding of a down payment meaning, let's move on to other related things.
 

How much should you pay as a down payment?

The answer to this is completely reliant on your budget and other financial obligations. Before deciding on this, you must always consider your existing debt EMI, child's education fees, insurance premiums, and household expenses. If you are not sure how to calculate a down payment, go to the lender's website and use the loan EMI calculator. It will assist you in determining how much of a down payment you can afford.
 

Benefits of Larger Down Payment

 

1. Lower Rates

   Down payment has a direct relationship with your loan interest rate. You reduce the lender's risk proportionally by making a higher down payment. It assures lenders that their funds will be secured even if you default. Therefore, they will approve you for a low-interest loan without hesitation.
    

2. Smaller EMIs

   A higher down payment equates to a lower loan amount. As a result, the EMI is reduced. Let's take a down payment example to understand this better.
    
   Let's say you want to buy a house with the help of a home loan. The house costs Rs 50 lakh. Your profile qualifies you for a maximum loan of Rs 35 lakh. Now, if you apply for a loan of Rs 35 lakh for a term of 10 years at a rate of 9%, your EMI will be Rs 44,337. However, if you increase the down payment and apply for a loan of Rs 25 lakh while keeping everything else the same, the EMI will be Rs 31,669.
    

3. Future Borrowing Capability

   Choosing higher down payments gives the impression that you have a strong credit profile. It also affects or rather improves your debt-to-income ratio (DTI). The situation ultimately helps in securing additional loans in future.
    

Benefits of Smaller Down Payment

 

1. Quick Purchase

   The down payment has a significant impact on your budget. If you want to buy a car, the down payment can range from a few thousand to several lakhs of rupees. When it comes to purchasing a home, down payments start at lakhs of rupees. Arranging such a large sum is difficult. Hence, by putting down the smallest amount of money upfront, you can buy a house, car, or bike swiftly and easily.
    

2. Emergency Reserve

   Emergencies, especially medical emergencies, are unwelcome visitors. They will demand sufficient funds to cope with them when they arrive. A lower down payment permits you to have sufficient finances on hand. You can use them to deal with any unanticipated crisis.
    

3. Other Priorities

   It is not a sensible decision to save a large sum of money solely to use it for a down payment. Paying a lower sum upfront allows you to meet your other financial obligations. You can put the money toward investments, retirement plans, or paying off any high-interest debts you have.
    

What is the Minimum Down Payment Requirement for a Different Loan?

Each loan type has its own minimum down payment requirement. To learn more, keep reading.
 

• Two-wheeler Loan 

This is perhaps one of those products that require only a small down payment. The lender will approve a bike loan up to 95% of the value of your bike. It means that if the bike costs Rs 1 lakh, you will have to pay Rs 5,000 out of your own pocket.
 

• Used Car Loan

Following the bike loan, a used car loan has the second-highest LTV. The lender will finance up to 90% of the cost of the car you want to buy. However, the size of the down payment is determined by many factors. Before arriving at LTV, the lender looks at the vehicle's condition, documentation, and age.
 

• Home Loans

Home loans are approved for up to 80% of the value of the property in question. However, the maximum LTV, or minimum down payment, is determined by several factors including the house's location, condition, builder's reputation, and more.
 
Also Read: Here’s Everything You Need to Know About the LTV Ratio
 

Factors Affecting Down Payment Amount

 

1. Credit Score

   Be it loan approval, interest rate, or down payment, a credit score is vital for all. This three-digit numerical expression informs the lender about how disciplined you have been with debt repayment in the past. You will need to put down a larger down payment with an average credit score.
    

Also Read: Top 10 Reasons Why Your Credit Score Has Gone Down
 

1. Income

   The income represents your repayment potential. It assists the lender in determining if you will be able to pay your debts on time. Prepare to put a larger down payment if you have an average income that fulfils the lender's minimum criteria.
    

2. Property in Question

   The down payment amount is also reliant on the condition of the used car/ house you are planning to purchase. 
    
   Let's say you want to buy a house in an underdeveloped region where the property condition is similarly poor. While inspecting the property's health, the surveyor discovers that it requires regular upkeep or it will only last 10 to 15 years. In this case, the lender will require you to make a bigger down payment. They may also charge you a higher rate to cover the major amount through interest payment.
    

3. Resale Value

   The down payment amount is directly proportional to the resale value of your bike, car, or home. Assume you have decided to finance a bike. The bike you are buying is an older version, and the manufacturer has released two or more improved versions in the market. Your bike's resale value will drop as a result of this. As such, if you default on your loan, the lender may not be able to recover all of their dues. Given this situation, the lender will ask for a higher down payment to mitigate their credit risk.
    

To Conclude

 
Down payment is the first thing that you must care about while submitting your loan application. It has an impact not just on your loan terms but also on your budget.