The importance and impact of down payments toward a loan is a widely-debated topic, especially now while interest rates are some of the lowest on record over the past 60+ years. It’s hard to go a week without reading or hearing about falling mortgage rates, zero interest financing, or the like. Sadly, there are some folks who espouse that down payments aren’t even necessary because borrowing money is nearly “free” in some cases. Hogwash! That is personal finance illiteracy at its finest.

I would argue that down payments are always important and impactful in any interest rate environment; thus, my goal in this article is to explain and illustrate why that’s the case. As informed financial decision-makers, we need to understand and appreciate how down payments impact the amount of interest we’ll pay over the life of a loan. Before we start, I want to share a simple rule of thumb for understanding the importance of down payments: the longer the term of the loan, the higher the interest rate, and/or the higher the amount financed, the more of an impact your down payment will have on how much interest you pay.

__Mortgages (Long Term, Low Rate, High Amount)__

Per the rule of thumb above, the longer the term of the loan and the higher the principal amount financed, the more impactful your down payment becomes. Mortgages are likely the longest-term loan you’ll execute in this lifetime; in fact, the most common term for a fixed-rate mortgage is 30 years. Some financial institutions even offer 40-year fixed-rate mortgages, although this became much less common after about 2008 or 2009 when more stringent lending standards went into effect. Let’s put this into some clearer context—if you take out a 30-year mortgage, on average that represents 38% of your life (assuming you experience an average lifespan of 78.6 years). Even if you lived to 90, that’s still 33% of your lifespan. It goes without saying that choosing the right down payment amount for your circumstances could make a major impact.

As of 2020, the median U.S. home price was $320,000. To keep things simple, we’ll use interest rates in this example instead of APR, which is your total cost to borrow, including various fees, taxes, closing costs, and one-time charges. The payments below also do not include property taxes, property insurance, HOA fees, or any other taxes or fees—in other words, they represent the house payment only. As of the writing of this article, the average 30-year fixed-rate mortgage interest rate is 3.060%. To understand the impact of a down payment, I’ll use four separate examples:

- 0% down payment: for illustrative purposes only
- 3.5% down payment: probably the minimum down payment you’ll find
- 12% down payment: the average down payment on a conventional mortgage as of 2020
- 20% down payment: often considered the “gold standard” of down payments, and in most cases, it also gets you off-the-hook for paying PMI (or private mortgage insurance—basically an insurance policy for the lender in case you default on the mortgage)

Now for the math:

**0% down on a $320,000 house at 3.060%**interest rate:- Total principal and interest paid over 360 payments =
**$489,540**– Yes, you read that correctly; to purchase a $320,000 home, you will pay a**$169,540 premium**(in the form of interest); that’s 53% of the purchase price paid as interest

**Monthly payment = $1,359**

- Total principal and interest paid over 360 payments =
**3.5% down on a $320,000 house at 3.060%**interest rate:- Total principal and interest paid over 360 payments =
**$472,506**– Reduced the total amount spent versus 0% down payment by $17,034; you will pay a**$163,706 premium**(in the form of interest); that’s 51% of the purchase price paid as interest

**Monthly payment = $1,311**

- Total principal and interest paid over 360 payments =
**12% down on a $320,000 house at 3.060%**interest rate:- Total principal and interest paid over 360 payments =
**$430,777**– Reduced the total amount spent versus 0% down payment by $58,763; you will pay a**$149,177 premium**(in the form of interest); that’s 47% of the purchase price paid as interest

**Monthly payment = $1,196**

- Total principal and interest paid over 360 payments =
**20% down on a $320,000 house at 3.060%**interest rate:- Total principal and interest paid over 360 payments =
**$391,678**– Reduced the total amount spent versus 0% down payment by $97,862; you will pay a**$135,678 premium**(in the form of interest); that’s 42% of the purchase price paid as interest

**Monthly payment = $1,087**

- Total principal and interest paid over 360 payments =

As you can conclude based on the above data, the amount of the down payment has a significant effect on how much you’ll pay to own the same house over time. Let’s go to the two extremes in the above example to illustrate the magnitude—0% versus 20%. By putting a 20% down payment against the mortgage, we would save $97,862 over the 30-year term ($489,540 total paid on the 0% down mortgage less $391,678 total paid on the 20% down mortgage), and our monthly payments would be $272 lower ($1,359/month on the 0% down less $1,087/month on the 20% down mortgage). Let’s take it a step further—assume you INVESTED the $272/month you save on the 20% down mortgage. Even with a relatively conservative average rate of return of 5%, that would grow to $222,686 after 30 years!

Now—please allow me to be transparent. There are some very savvy folks who would argue that the 0% down mortgage (if such an instrument existed) is theoretically the smarter choice compared to those mortgages with higher down payments. The reason is you could take the initial $64,000 (representing the 20% down payment you could have made) and invest that at the same 5% rate of return and have $276,604 at the end of 30 years instead of the $222,686. Even netting out the incremental interest you pay on the 0% down mortgage, you’d come out ahead by about $20,506.

My counterpoint to that argument would be that you’re subjecting your money, and therefore your future, to significantly more market risk if you choose to go the 0% down and invest the $64,000 route. You would experience 30 years of market risk on 100% of that $64,000 instead of experiencing incremental market risk $272 at a time as you invest monthly. To me, the return isn’t worth the risk! But that’s the beauty of investing—each person has his or her own levels of risk tolerance.

Another counterpoint, which I did not factor into my models above, is that PMI has a crippling effect on your monthly payment. It’s typically calculated at 0.5% to 1.0% of the total mortgage principal balance, which means on a 0% loan, you’d pay $1,600/year, assuming 0.5% PMI (or $133.33/month) in PMI until you repaid 20% of the original principal balance. Just in case you’re interested, that would happen somewhere around 8 ½ years into the mortgage and would cost you another $13,600 in PMI. The PMI drops off at that point, which is one of the advantages of the 20% down mortgage—no PMI required!

__Vehicle Loans (Short Term, Medium Rate, Moderate Amount)__

Now let’s go to the other end of the debt spectrum—vehicle loans. Vehicle loans are covering increasingly pricier vehicles for longer terms. As of the writing of this article, the average new vehicle loan was for $32,480 with an average rate of 5.27% and a term of 69 months. There are many lenders who are able and willing to offer vehicle loans up to 84 months!. Compare that to 20 short years ago in the year 2000 when the average new vehicle loan was for $20,923 at an average rate of 5.50% and a term of 55 months. Even though this article isn’t solely about new vehicle loans, consider the changes to how we finance vehicles over the last two decades. The average loan has gone up $11,557 (55%), the rate is relatively flat, and the average term has increased by 14 months (25%). That means there are some inherently big challenges when it comes to car loans and responsibly managing personal finances.

Similar format as above—to understand the impact of a down payment, I’ll use four separate examples:

- 0% down payment
- 3.5% down payment
- 12% down payment
- 20% down payment

And the math (excluding any applicable taxes and fees—vehicle only):

**0% down on a $32,480 vehicle loan at 5.27%**interest rate:- Total principal and interest paid over 69 payments =
**$37,720**– You will pay a**$5,240 premium**(in the form of interest); that’s 16% of the price paid as interest

**Monthly payment = $547**

- Total principal and interest paid over 69 payments =
**3.5% down on a $32,480 vehicle loan at 5.27%**interest rate:- Total principal and interest paid over 69 payments =
**$36,400**– You will pay a**$5,057 premium**(in the form of interest); that’s 15% of the price paid as interest

**Monthly payment = $528**

- Total principal and interest paid over 69 payments =
**12% down on a $32,480 vehicle loan at 5.27%**interest rate:- Total principal and interest paid over 69 payments =
**$33,193**– You will pay a**$4,610 premium**(in the form of interest); that’s 14% of the price paid as interest

**Monthly payment = $481**

- Total principal and interest paid over 69 payments =
**20% down on a $32,480 vehicle loan at 5.27%**interest rate:- Total principal and interest paid over 69 payments =
**$30,176**– You will pay a**$2,304 premium**(in the form of interest); that’s 7% of the purchase price paid as interest

**Monthly payment = $437**

- Total principal and interest paid over 69 payments =

The amount of the down payment has a significant effect on how much you’ll pay to own the vehicle house over time—although to a comparatively lesser degree than a house, due to a smaller principal amount and shorter term. Let’s go to the two extremes in the above example to illustrate the magnitude—0% versus 20%. By putting a 20% down payment against the loan, we would save $7,544 ($37,720 total paid on the 0% down loan less $30,176 total paid on the 20% down mortgage), and our monthly payments would be $110 lower ($547/month on the 0% down less $437/month on the 20% down loan).

__Summing It All Up__

After studying the two examples above, it should be clear how much of an impact a down payment can make on your debt. To be fair, I do not believe a huge down payment is always the right answer. The amount of the down payment should be tailored to your personal financial situation. If you only have enough cash to put a 5% down payment against your home or vehicle, that’s okay! What matters most is that you understand the impact it can have on the interest paid over the life of the loan and therefore your monthly payment. If you decide your money can provide better returns if invested elsewhere, and you want to put 0% down, kudos! More power to you.

At the end of the day, interest on borrowed money can be crippling if you allow it to be. Analyze, analyze, analyze, and make the best overall decision you can make for your finances!