Down payment

Down payment (also called a deposit in British English), is an initial up-front partial payment for the purchase of expensive items/services such as a car or a house. It is usually paid in cash or equivalent at the time of finalizing the transaction. A loan of some sort is then required to finance the remainder of the payment.

The main purposes of a down payment is to ensure that the lending institution has enough capital to create money for a loan in fractional reserve banking systems and to recover some of the balance due on the loan in the event that the borrower defaults. In real estate, the asset is used as collateral in order to secure the loan against default. If the borrower fails to repay the loan, the lender is legally entitled to sell the asset and retain enough of the proceeds to repay the remaining balance on the loan, including fees and interest added. A down payment, in this case, reduces the lender's risk to less than the value of the collateral, making it more likely that the lender will recover the full amount in the event of default.

The size of the down payment thus determines the extent to which the lender is protected against the various factors that might reduce the value of the collateral, as well as lost profits between the time of the last payment and the eventual sale of the collateral.

Furthermore, making a down payment demonstrates that the borrower is able to raise a certain amount of money for long-term investment, which the lender may desire as evidence that the borrower's finances are sound, and that the borrower is not borrowing beyond his or her means.

If the borrower is unable to pay off the loan in its entirety, the down payment amount is forfeited.