Every home purchase is going to require a down payment of some sort or another. But how much of a down payment should you put down on your home?
Typically, the down payment is going to be 3% to 5% of the cost of the house. Those numbers, however, can vary. Buyers with struggling credit scores may have to put down higher down payments. Different types of loans can also dictate the amount of the down payment.
What if you have the luxury of affording a larger down payment than necessary?
Do not believe the mortgage company who tells you to hang onto your cash and just take out the loan. Granted, that may be an option you choose to take for a variety of reasons. But remember, the mortgage company is in the business of making money. At the end of the day, they want to make money off of you and your loan.
A larger loan may well work for you and the mortgage company. However, I always tell people to arm yourself with information from both sides. And so, below are 5 reasons why a larger down payment, if possible, may well benefit you.
#1 - Lower Mortgage Payments
A larger down payment means you will be borrowing less. Borrowing less, in turn, means your monthly payments will be less as well. That means more money in your pocket for purchasing other things and/or for saving. This could be especially helpful if you have a young and growing family, or if you are older and heading toward retirement.
You could even take that extra money and make an extra payment or two on the house. Did you know that paying one extra payment a year can take years off your loan and significantly lower the amount of interest you will pay over the life of the loan?
Just having the flexibility of more cash flow per month offers is a win-win for you, the homeowner!
#2 - Avoid Paying Mortgage Insurance
Mortgage insurance, called PMI (private mortgage insurance), is a type of insurance that protects against default on home loans. PMI allows buyers with less than 20% of a down payment to purchase a home while mitigating the risk of that loan to the mortgage company.
Without a 20% down payment, it is almost impossible to get a conventional loan without the requirement of PMI, and the PMI is added to the monthly mortgage. The higher the loan, the greater the PMI. The PMI cannot be dropped from the monthly mortgage amount until 20% equity has been reached in the home. This equity could simply be by making payments over time, or by waiting until the house appreciates in value, or both.
FHA loans require a similar insurance called MIP, or mortgage insurance premium. Unlike conventional loans, however, the homeowner will pay the MIP for the duration of the loan.
#3 - Save Money by Paying Less in Interest over the Life of the Loan
Mortgage loans are amortized, and thus, for the first few years of your loan, only a small percentage of each monthly payment (excluding PMI if required, taxes, and insurance) will go to the principal. The bulk of the monthly payment will go to the interest on the loan. As the interest is paid down, more of the monthly payment will go to the principal. This is why you get very little traction into the equity for the first few years of owning a house, unless you make extra payments. (Or, unless you put a large down payment into the home. More on that in a moment.)
Borrowing less, of course, means you will pay less in interest over the amount of time you keep the loan. And paying less, of course, means more money in your pocket for other things!
#4 - Immediately Gain Equity in Your Home
The larger your down payment, the more money you immediately have in your home. For example, if you purchase a house for $350,000 and you put only 3% down on the house, you have put down $10,500 and you will owe the bank $339,500. If, however, you purchase that same home for $350,000 and you put down 10%, or $35,000, then you owe the bank $315,000. That is a difference in a loan amount of $24,000. Not only will the amount of interest you owe be less, but you will walk into your home with $24,000 equity as opposed to only $10,500, and you will be that much closer to being able to walk away from the PMI insurance on the monthly payment.
Imagine how much money you can save and how much immediate equity you can have in your home by putting 20% or more on a down payment!
#5 - Stand Out with a Competitive Offer to Sellers
It is a misnomer to believe that sellers appreciate overpriced offers or, in multiple offer situations, will always choose the highest offer. Sometimes, sellers will take other considerations into account. A buyer with a larger than normal down payment is a serious buyer, and such an offer will easily stand out among other offers even if the offer is not necessarily at or over asking price.
Building wealth - just by living in your home . . .
While you live in your home, the home is accruing equity as you begin to pay down the principal. This equity building may be slow at first, depending upon the amount of your down payment, but over time it will begin to snowball. Added to this can be updates you make to the home and market prices that almost always move upward. It is almost a sure bet that under normal circumstances, if you stay in the home for five years, the house will be worth more than when you purchased it five years previous.
If you have put a rather large down payment on the home, your equity will build even faster, and the wealth you can build through home ownership will snowball even faster. Of course, at some point, you will decide to sell that home. When you do, you will have even more available cash to use as a down payment on the next home, or perhaps, you will down size and use that cash for other sorts of investments. The choice is yours, of course. The important thing is - you will have options, because wealth brings options.
And who doesn't want more money tomorrow than they have today?
Donna Hechler Porter is a real estate agent with Keller Williams Elite Realty in Baytown, Texas. An educator, a published author, and an arm-chair historian, Donna runs a small publishing business in addition to educating people about how to build future wealth through home ownership. Feel free to contact Donna at dhporter@kw.com.