When Is It Worth Putting a Down Payment of More than 20%?
Buying real estate can be a stressful experience. Finding the right house is a long and painstaking process.
Not to mention, a home is likely to be the most expensive thing that you ever purchase, so you’ll probably need to take out a mortgage to afford one.
There are a variety of mortgages available that require different levels of down payment. Some mortgages require a down payment as low as 3.5%.
The standard down payment on a property is 20%. This will let you qualify for the best loans and avoid paying additional fees such as PMI.
If you have the financial ability, you might wonder whether it makes sense to put down more than 20% for a down payment.
There are several reasons you might want to do this:
1. You Have Irregular Income
Housing costs are usually the largest single cost of an American family. Whether it be rent or a mortgage payment, Americans pay thousands a month to keep a roof over their head.
With a regular income source from your job and know how much money you’ll make each month, you can easily budget for your housing expense.
If your take-home pay is $3,000 a month, you know not to spend more than roughly $1,000-$1,500 on housing. That leaves enough money for you to handle your other bills.
Without a regular source of income, budgeting for your housing expenses is more difficult. Small business owners, freelancers, and people who work jobs with irregular hours often can’t predict how much they’ll make in a month.
If you’re in that situation, you want to make your housing payment as low as possible. The less money you’re forced to spend each month, the easier it will be to adapt to your changing income.
The size of your down payment directly impacts the monthly payment you have to make. Making a large down payment means you have to pay less each month.
If you have the cash on hand, but an irregular income, making a large down payment can help you make ends meet each month.
2. You're Asset-Rich, But Income-Poor
Relatedly, if you are asset-rich, but income-poor, making a large down payment can be a good idea.
You can put the money you have available to you now to work, using it to purchase your new home.
That will reduce the monthly payments you’ll be making over the next 15 to 30 years.
If you don’t make a lot of money each month, having the lower payments will make it easier to make and meet a budget.
3. You’re Heavily Invested in Volatile Assets
Investing in volatile assets like stocks is a good way to grow your savings. On average, the U.S. stock market has returned 9-10% per year over the past century.
However, that return hasn’t been steady. Some years see stocks drop in value by more than 50%. Other years see growth exceeding 20%.
Real estate can also be volatile, but it is less volatile than stocks are. If you have a lot of money tied up in stocks or other volatile investments, putting some of that money into your down payment helps you diversify.
You’ll have more equity in your home, a relatively secure asset, which you can use as you need through a HELOC or home equity loan.
4. You Want to Avoid Jumbo Loans
If you are purchasing a particularly expensive home, you might be looking at getting a jumbo mortgage rather than a standard mortgage.
These loans can have different terms than standard mortgages do. Specifically, they may have stricter qualification requirements or charge more interest.
Given the additional fees and restrictions, you can benefit by getting a standard mortgage rather than a jumbo loan. In most parts of the country, this means getting a loan for $453,100 or less. In the most expensive parts of the country, the limit for non-jumbo loans is $679,650.
If you can make a large down payment to avoid getting a jumbo loan, it can help you qualify for the loan and pay less interest.
5. You Don’t Like Debt
One of the most obvious reasons to make a larger down payment is that you don’t like debt.
Disliking debt is understandable. Nobody likes to feel like they owe someone something. Debt is worse than that because you get a bill every month reminding you of exactly how much you owe to the lender. Worse still, missing a payment can result in a ruined credit score and ultimately foreclosure on your home.
Some people don’t mind debt and see it as a useful tool. Others see debt as something to be avoided at all costs. Personal finance, as its name implies, is innately personal. There’s no one size fits all answer to some questions.
If you don’t like debt, don’t discount the psychological importance of doing what you can to avoid being in debt.
Making a large down payment will reduce how much you owe to your creditor. It also makes it easier to pay the loan off, helping you get out of debt sooner.
6. It’s Harder to Be Underwater on Your Mortgage
When you take out a mortgage to purchase a home, you hope that your home’s value stays the same or rises. In some cases, the value of your home will actually fall.
So long as you can make your monthly payments this isn’t a huge problem. However, if you can’t make your payments, or want to move, it becomes a major issue.
To sell your house, the usual course of things is to sell your home, use the proceeds to pay off the mortgage, and to pocket the excess. When you suddenly owe more than your house is worth, it’s your responsibility to pay off the difference.
If your house is worth $80,000, but you owe $100,000 on the mortgage you need to come up with the additional $20,000 before you sell your home.
This was a major issue in the 2008 recession, as falling home value caused many Americans to be underwater on their home loans.
Making a larger down payment will increase the equity you have in your home. It will also reduce how much you owe, making it harder to get underwater on your home if your home’s value drops.
7. You Want to Pay Less Interest
One of the downsides of borrowing money is that you have to pay for the privilege.
Lenders charge interest based on the balance of your loan. Each month, you pay the interest that has been charged, and a portion of the loan’s principal until the loan has been paid in full.
The less you owe, the less interest you will be charged each month. Making a large down payment will reduce the amount you owe right off the bat. That means you’ll be charged less interest from the time you get your loan.
As a bonus, the interest rate on a loan is determined, in part, by the amount of risk the lender accepts by making the loan.
Loans with larger down payments are less risky than similar loans with smaller down payments. Offering a larger down payment can help you secure a lower interest rate, giving you even larger savings.
8. Your Offer Is More Likely to Be Accepted
When you purchase a home, the seller will take the house off the market after your offer is accepted. However, your offer is generally contingent on a number of things, including securing financing.
In the event that an offer is accepted but you get declined for a mortgage, the seller will need to go through the whole home selling process again.
If you have a large down payment, that significantly reduces the odds of your mortgage application being denied. That means that making a larger down payment can improve the chances of your offer to buy a house being accepted, especially in a multiple-offer situation.
Given two near-identical offers, with the only difference being the size of the down payment, the larger down payment will generally win.
Don’t Forget the Opportunity Cost of a Large Down Payment
When deciding whether to make a large down payment, you should also consider the opportunity cost. You’ll save on your monthly payment and pay less interest, but you might have been able to do more with that money if you hadn’t used it for a down payment.
You can consider your down payment as similar to purchasing a guaranteed return equal to the interest rate of the loan. So, if your mortgage charges 5% interest, adding $10,000 to your down payment is like getting a guaranteed 5% return on that amount.
Given that the U.S. stock market has averaged returns of nearly 10% each year over the past century, it’s quite possible that you could have earned more by investing that money instead of using it for a down payment.
You need to make the decision as to what level of risk you’re willing to take on when deciding on the size of your down payment.
Conclusion
Making a down payment in excess of 20% brings a number of advantages when you’re looking to buy a home.
Still, you should be aware of the opportunity cost of making a large down payment.
