Your Down Payment On A House
Balance is vital when you think about your down payment on a house. If you think you might sell the house within just a few years of ownership, having a sizeable down payment exposes you to a higher risk if real estate prices fall. However, a larger down payment can also mean lower monthly payments.
The value of $1,000 is pretty hard to quantify, especially in a real estate market that might have $30,000 homes and $300,000 homes. Instead of considering the amount of money, think about a percentage of the house’s value. When making these decisions, here are three questions to ask yourself.
Can I put 20% down?
A down payment of 20% is something of a magic number. With 20% down, borrowers are no longer responsible for carrying Private Mortgage Insurance (PMI). PMI is a protection most lenders require to cover their investment in you should you not repay your loan. You pay the premiums for this insurance. Either as a lump sum payment at closing or included with the mortgage payment. But including it makes your monthly payment much higher. PMI usually costs between 0.5% and 1.0% of the loan’s value, though prices vary based on several factors. Using this model, on a $100,000 loan, expect to pay around $83 more per month.
20% is also a magic number for interest rates. Lenders see a 20% down payment as a sign of a responsible borrower. Meeting that down payment amount means the borrower typically has a lifestyle of spending responsibly and saving money, which are signs of stable credit risk. Regardless of your credit score, a 20% down payment can help save on the costs of the loan.
Can I get help to buy my home?
A wide variety of homebuyer assistance programs are designed to help people reach that 20% threshold. These come in two forms: grants and delayed repayment loans. They’re offered by housing departments at all levels of government and frequently go unused because homebuyers don’t think they qualify.
Grants are no-strings-attached checks that you have to use for a specific purpose; in this case, the down payment on a home. Many limits by income level or region of purchase, but they are worth exploring. Even more, options are open to first-time home buyers, former or current members of the armed forces, and people in public service-oriented professions.
Delayed repayment loans are similar. These are second mortgages held by an organization for a portion of the total cost of the house. They do not begin accruing interest until after you’ve paid off your primary mortgage, and some of them are forgiven after you’ve owned the home for a certain amount of time. These are available from housing authorities and private organizations all over the country.
One important note:
While you can get a lot of help, you cannot use another loan, even one from your parents or relatives, as part of your down payment. Doing so is a federal crime and can get you in serious trouble! In the best case, lenders will be suspicious of large deposits you can’t explain and may even refuse to issue the mortgage loan.
There are several options if you can’t get to a 20% down payment. You could make the smaller down payment, understanding that you’ll have to pay higher interest rates and PMI. Or you could also look at houses in lower price ranges. And you might even decide to postpone home ownership and focus on saving so you can get there the next time.
Should I go over 20%?
Making a substantial down payment is an investment. Think of your mortgage as a savings account. You make an initial “deposit” when you make a down payment. A portion of your payment goes into your account each month, while the rest covers interest, which is the price you pay for living in your savings account. The return on your investment in the large initial down payment is the lower total interest you’ll have to pay.
When deciding to put more than 20% down, consider your mortgage rate as the rate of return. If you can place another $1,000 down, that’s $1,000 less you’ll need to borrow. If your interest rate is 4%, then the return on that investment is $40 in interest you don’t have to pay. On the other hand, you don’t have that $1,000 to invest somewhere else now. If your retirement account earns 5%, that same $1,000 will receive $50 if spent there. You are making the larger down payment will end up “costing” you $10 in the long run.
As with any other investment decision, weigh the pros and cons. Your down payment on a house is no different. It may have a comparatively low rate of return, but the risk is negligible. Unless the value of your house drops dramatically, you won’t lose your down payment. It can be smart to put down as much as you can, but make sure to leave your retirement and emergency funds intact. If you like this post, check out our other posts on our MoneySmart Tips Blog.
