In theory, all of the money you put in as a down payment goes to reduce the size of your home loan. In practice, not all of the money you bring to cover the closing on a home purchase will be counted toward paying down the loan. Go over the numbers with your mortgage lender before closing on the home to find out what will happen with the money you initially planned to be your down payment.
Down Payment Basics
The basic down payment math involves subtracting the amount you want to put down from the home's selling price to get the starting loan balance. For example, you agree to buy a home for $200,000 and want to put 10 percent, or $20,000, down. After the down payment, the loan would be $180,000. Put less money down, you start out with a larger mortgage loan; a bigger down payment results in a smaller starting loan amount.
Add in Closing Costs
Your planned down payment is not the only money you need to pay when you close the deal on a home purchase. The mortgage lender needs to collect additional money to cover costs such as lender fees, title insurance, and escrow money for your taxes and insurance. These closing costs add up to several percent of the loan amount and must be paid when you sign the papers for your new home and new mortgage loan. If the closing costs were $4,000, you'd need to pay $24,000 to end up with a $20,000 down payment against the cost of the home.
Rolling Costs to Loan
If you have a certain amount of cash to put down on a home, the closing costs must first come out of the money you may be thinking of as your down payment. Whatever is left after the costs are paid is your actual down payment and is reflected in the initial loan amount. If you have only $20,000 to get into a home, and the closing costs are $4,000, your actual down payment will be $16,000. This leaves you with an initial loan balance of $184,000 on a $200,000 purchase price.
Example From FHA
The widely used mortgage program insured by the Federal Housing Administration graphically shows what can happen to a planned down payment amount. Through the FHA program, you could buy a home with a down payment as low as 3.5 percent -- as of 2013. You must also pay an up-front mortgage insurance premium of 1.75 percent, which the rules allow you to roll into the loan balance. If you financed your $200,000 home through the FHA, the required down payment would be $7,000, leaving a balance of $193,000. The mortgage insurance premium, though, would be $3,377.50, increasing your loan balance back up to $196,377.50. Your 3.5 percent down payment actually works out to a 1.8 percent reduction on your final loan balance.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.