For a borrower without an excess of liquid capital, this can seem like a dream come true since it allows for the acquisition of the loan without sacrificing a chunk of income that could instead—in theory—be used as a nest egg to pay for the loan’s initial payments. This mindset isn’t unwarranted, but it’s the psychological response expected from lenders to lock you in to a payment plan that may not fall within the scope of what’s financially sustainable to you.
The Purpose of Down Payments
From a lender’s perspective, down payments demonstrate financial health. The larger a down payment, the more readily a borrower will be viewed as creditworthy since money used for down payments is disposable income. The loss of that money won’t (at the very least, it shouldn’t) disrupt the borrower’s financial stability. This also means that the borrower can be trusted to generate income that supports the terms of the loan. In other words, they can be assured that they’ll reliably collect any accrued interest over the term of the loan.
As for the borrower, down payments are tools to reduce monthly payments over the loan term. They are a tool used to adjust monthly payments to fit within the borrower’s budget. This is why negotiating down payments, interests rates, and the term of loans is such a contentious issue between lenders and borrowers. Lenders benefit from lower down payments, higher accrued interest as well as rates, and longer loan terms whereas borrowers benefit from the opposite. By forgoing a down payment, potential borrowers increase their financial risk, especially in the case of emergencies for long-term loans.
The Zero Down Payment Psychology
Not having to put money down for a loan is a steal for both parties. What often goes unsaid is that it’s a long-term steal for the lender but only a short-term steal for the borrower. Despite not pocketing any money up front, lenders benefit from tens of thousands of additional dollars in accrued interest. Meanwhile, the borrower suffers the ramifications of that interest, some of which could have been averted with a down payment.
Lenders understand that most borrowers are mostly considering their present financial situation. Borrowers with unhealthy finances are more likely to jump at the opportunity to acquire an asset without suffering a financial hit, oftentimes because they’re negotiating for an asset that will add substantial value to their quality of life. Rather than looking at the financial implications three, five, or ten years into the future, they look only at the immediate implications. They perceive $5000 dollars of savings instead of the $15000 in additional payments. By the end of the loan term, most borrowers won’t even be cognizant that they spent $10000 more on the purchase than they could have. When it comes to down payments, purchasing decisions are based on both emotion and finances, the former of which often overshadows more rational considerations.
Exceptions to the Rule
On a purely numerical basis, there aren’t many arguments to be had about foregoing down payments being a benefit to the borrower. Present wisdom indicates that if a borrower can’t afford to make an impactful down payment, then they aren’t financially stable enough to be making the purchase in the first place. This isn’t to say that there aren’t circumstances in which a loan that doesn’t require a down payment might be viable and non-predatory. In fact, Bank of America is offering one such opportunity with the goal of increasing home ownership among minorities. It should be considered that this opportunity is still just an experiment, and its value is yet to be proven. Another consideration is that this program seeks to remedy a system that underserves certain communities by crippling them rather than addressing it in the simplest way: offering non-white borrowers the same rates as white borrowers (assuming both borrowers have identical income and credit history).
Making Life-Changing Decisions
Patience is the greatest virtue when it comes to making potentially life-changing financial decisions. While making smaller down payments can provide some immediate financial relief, the long-term implications can often be devastating, especially for a borrower with tenuous financial stability. Whenever possible, it’s always best to accrue enough disposable income to offset interest and monthly payments rather than move full steam ahead with a contract that may become crippling over the following years.
