Down Payment

A down payment is the portion of a property's purchase price that the buyer pays in cash at closing rather than financing through a mortgage. The down payment directly determines the initial loan-to-value (LTV) ratio — a property purchased for $200,000 with a $40,000 down payment results in a $160,000 mortgage and an 80% LTV. The larger the down payment, the more equity the borrower holds from day one and the lower the risk to the lender.

Standard Down Payment Requirements

Down payment requirements vary by loan type and have evolved significantly over the history of U.S. mortgage finance. Before the 1930s, lenders routinely required 50% down on short-term balloon loans. Government programs introduced during the Great Depression transformed this landscape:

When the down payment is less than 20% on a conventional loan, lenders require mortgage insurance (PMI) to protect against the increased risk of default. Government-backed loans (FHA, VA, USDA) have their own insurance or guarantee mechanisms that allow lower or zero down payments.

Why Down Payments Matter to Note Investors

Original Down Payment and Default Risk

The original down payment on a loan reveals how much skin the borrower had in the game at origination. A borrower who put 20% down started with meaningful equity and a lower monthly payment relative to the property's value. A borrower who put 3.5% down had almost no equity cushion — and any decline in property value pushed them underwater, increasing the likelihood of default.

When reviewing a data tape of loans for purchase, the original LTV is one of the key fields that tells this story. High original LTVs (above 90%) correlate with higher default rates, particularly on loans originated during periods of inflated property values.

Down Payments in Loan Modifications

For non-performing loan investors, the term "down payment" takes on a second meaning: a lump-sum cash payment collected from the borrower as a condition of a loan modification agreement. This upfront cash serves multiple purposes:

• Demonstrates borrower commitment — A borrower willing to put cash toward a resolution is signaling genuine intent to save the home
• Accelerates the investor's return — Immediate cash recovery reduces the net basis in the investment
• Reduces risk — Each dollar collected upfront is a dollar the investor no longer needs to recover through future payments or foreclosure

As outlined in How to Value NPLs to Make an Offer, modification modeling includes factoring in "a potential down payment" because "many modification agreements include a lump-sum payment from the borrower as a condition of the new terms."

Case Study Example

In a case study profiling a 121% IRR, an investor purchased a non-performing second lien for $15,750. The borrower agreed to a $400 down payment and a new monthly payment of $442. After seasoning the loan with consistent payments, the investor sold the re-performing note for $30,033. The modification down payment — though modest — signaled borrower commitment and contributed to the deal's strong return.

Down Payment and LTV: The Equity Equation

The relationship between down payment, LTV, and equity is foundational:

Equity = Property Value − Mortgage Balance

At origination, equity equals the down payment. Over time, equity grows through two mechanisms: the borrower's monthly principal payments reduce the mortgage balance, and property appreciation increases the value of the collateral. Conversely, equity erodes when property values decline or when the borrower falls behind on payments and accrued interest and fees increase the unpaid principal balance.

For note investors evaluating a potential acquisition, the current LTV — not the original down payment — is what determines collateral coverage. A loan originated with 3.5% down in 2010 may now have substantial equity if the property has appreciated significantly. A loan originated with 20% down in 2006 may be underwater if the property lost value and the borrower stopped paying.

Practical Considerations

• High-LTV originations are not disqualifiers — A loan originated with minimal down payment may still be a strong investment today if the property has appreciated and the current LTV is favorable
• Always model modification down payments — When pricing NPLs, include a realistic down payment assumption in your modification scenario to avoid overpaying
• Down payment size signals borrower capacity — During workout negotiations, a borrower who can produce a larger lump sum upfront is more likely to sustain ongoing payments