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Down Payment
The term down payment is often used in transactions of expensive items like cars or houses, in which the loan is required to be paid in full. A down payment is essentially an initial deposit with the rest of the loan to be paid, usually monthly, at later times. Down payments are often made in the form of cash or check. The amount of the down payment varies depending upon the selling price and the contract made between the seller and the buyer. Its main purpose is to ensure the lending institution an easier recovery of the loan in case the borrower goes into default or cannot go through with the deal.
Once the down payment is made, the asset is used as collateral to secure the loan against default. If the borrower cannot fulfill the required obligations to pay off the loan, he or she will automatically forfeit the down payment. The lender, then, is legally entitled to sell the asset and is allowed to retain enough of proceeds to cover the original amount of the load. Instead of having the sell the property at the full price, the lender will only have to recover the difference between the original purchase price and the down payment.
The way to calculate the down payment in percent is 1 minus the LTV—the ration of loan to value. For instance, the loan of $198,000 is 85% of the purchase price of $240,000. So 1-0.85 = .175 or 17.5%. The amount of down payment on this loan is $42,000. The LTV helps eliminate the confusion on what constitutes a down payment. It is helpful to know that mortgage insurance is required when the LTV is more than 80%. The same is true when the down payment is less than 20%. It is also good to know that in some cases, people who want to build a house on their own land can use the land as a down payment or part of it. This practice is acceptable.
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