Downpayment Why A Larger Down Is Better
Down-payment: Why a larger down is better? How much should you have?
In short: A down payment + A mortgage = Total purchase price of a home.
Normally, you can’t get a mortgage covering 100% of the house price. Lenders require you to spend some money called down payment. This up-front cost usually ranges between the minimum of 3.5% to 20% or more.
Know what? Many home buyers consider down payment the no.1 obstacle to buying a home.
Well, you are probably not an exception.
So why do we need to put up a down payment?
If you were a lender, what would you look for in your borrowers?
One of the top considerations would be their ability to pay you back.
You would want to make sure your cash come back to you, both principal and interest. Do you think someone is able to pay you back if he can’t put up a down payment? I’m afraid he doesn’t.
And most lenders think so.
Why a larger down payment is better?
Better chances of being approved
It is clear that the more money you put down, the better you look to lenders.
If you can afford a higher down payment, you are more likely to pay them back. And when you gain their trust, you have better chances of being approved when applying for a mortgage, like beating out other buyers with just 5%-10% down.
Today, a down payment of 20 percent or more of your home’s price is considered safe for most lenders. If your down payment reaches these numbers, you don’t have to get PMI (Private Mortgage Insurance) – which protects the lender from loss in case you fail to pay.
Without PMI? You get rid of an additional monthly cost.
Be careful with those lenders who offer no PMI loans.
The lender might add a percentage to the mortgage interest rate instead of requiring you to get mortgage insurance yourself.
It is much different from buying PMI outright, which the interest rate is lower and you can stop paying once the equity in your home reaches 20 percent.
Quickly build up equity
As described in this post – What’s so great about buying and owning a house?, your down payment instantly becomes your property’s equity after purchasing. The more you put down, the better financial advantages you have.
This would also prevent you from loss if you had to sell your house in short term.
A higher down payment means lower interest rates and total payment
A mortgage with 20 percent down often has lower interest rates since it is less of a risk for lenders than a mortgage with less money down.
A higher down payment also means borrowing less money, reducing both your monthly and lifetime mortgage costs.
I will give you an example so you could better imagine how a big down payment could save you tens of thousands of dollars over the life of the mortgage.
Let’s say you buy a $300,000 house with a 30-year mortgage at a fixed interest rate of 4%, and 0.6% PMI for all under 20 percent down. Property tax is not included.
So here is how your mortgage payment breaks down (I use this tool to calculate mortgage payments with PMI):
As you see, putting $10,500 down at 4% instead of $60,000 down at 4% costs you $50,050 more overall. Notice that the interest rates are the same in this example.
In fact, you even get a lower interest rate for putting down 20%.
How much down payment should I save for?
Well, if your budget is not tight, you should always aim to put down at least 20 percent, things will be a lot easier.
On the other hand, there are some reasons to not save up that much.
Future house prices
You could save for several years to get over 20%, but notice that by then the house prices could probably increase much higher.
My friend, will you continue to save for another years and hope that this won’t happen again?
Low interest rates
At the time I write this, a 30 year mortgage has a fixed interest rate of roughly 3.87%, which is relatively low.
You can’t always get this good rate. Remember the lender who offers no PMI loans I’ve mentioned above? Hmm, the marketplace takes over his role in this case.
The time value of money
Suppose you have $20,000 in cash and are going to buy a $100,000 house.
If you put all $20,000 down and get a 4% mortgage, you will pay a monthly payment of $486.10 for 30 years, for a total of $174,995.61
If you put $5000 down, and say, get a 5% rate, you will pay a monthly payment of $614.15 for a total payment of $221,093, but you will have $15,000 in the bank.
So, putting $5000 down at 5% instead of $20,000 down at 4% will cost you about $53,000 more over the life of the loan.
But what about that $15,000? If you were to put that $15,000 in an investment and get a 6% annual return on it for 30 years, you will have $86,152. You will have made $71,152 in investment returns.
So, by putting only $5,000 down, and investing the rest, you could (note COULD) come out $21,000 ahead over 30 years.
But a lot of this is dependent on luck. This sort of math only makes a lot of sense when you’re buying an affordable house, such that the house payments are not going to be a stretch regardless. There’s a lot to be said for the flexibility that having a much lower house payment might get you.
So this, in brief, means you can probably make more money in return by investing some money in stocks, bonds or similar things, than putting all your cash in your property’s equity.
Save yourself from rent
But assume you’re paying $1500-2000$/month for a fully furnished house, with a yard, a garden, and things like that.
A $300,000 loan at today’s rates with 15% down would have you paying approximately $1800 towards your mortgage and other costs of owning a home.
If you get that mortgage to buy a house, your monthly payments will likely remain unchanged, plus you have your own place. (Check Should I buy or rent a home calculator)
So why you need to save for a really big down payment if there is not much difference.
Stuff your house
If you are a first-time house buyer, you perhaps have no idea of what items you need to buy for your new house.
Random stuff such as keys & locks, lawnmower, garden supplies, tools & repair items, and so on can cost you a lot more than you think. So to get a head start with your new home, you may want to subtract a percentage from the down payment for those things.
What to do?
In conclusion, if you can’t afford a 20% down payment but you are in a good situation financially, combined with all the factors I’ve listed above, think about moving to a new house earlier.
Author: Tosha Stapleton
April 5th 2015
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