Pop Quiz: When it comes to putting money down on a new house, you should:
- See if they’ll accept Monopoly money
- Put down as much as possible
- Put down as little as possible
- Pay in doughnuts
As much as Answer A would be nice, in most cases, you will put some sum of money down when buying a new house. But the amount will vary, and every situation is different. You’re probably wondering if you will have enough money to slap down to buy the house and then finance the rest. Many people think they must have a big chunk of change for a down payment in order to even buy a home. That’s simply not true.
There are pros and cons to putting money (any amount) down on a home. Some lenders and industry professionals have preached the “20% down” gospel to as many potential homebuyers who will listen. But times are different now – interest rates aren’t what they used to be and new loan programs can be had for far less than 20% down. Also, there are cases where that large of a down payment doesn’t benefit the buyer. Here are some pros and cons of large down payments:
PROS of Large Down Payments
The interest rate may be lower
A 20% down payment vs. a 3.5-5% down payment communicates to the lender that you are financially stable and is not a huge risk to default on your loan. Chances are, you manage your money well, are a disciplined saver, and have a good track record of paying off debt.
The more confident the lender is in your credit score and ability to pay the loan, the lower the mortgage interest rate they’ll be willing to give you. It’s a risk-reward thought process.
You may pay less for the home
Really? Yes, really. It’s simple math – the more money you put down, the less you will have to borrow. That means you won’t pay as much interest over the life of the loan.
If you can pay 20% of the cost of the new home at the start of the transaction, you’ll only pay interest on the remaining 80%. On the other hand, if you put down 5%, the additional 15% will be added to the loan and accrue interest over time. This will cost you more over the lifetime of the home loan because you are paying more in interest.
No Private Mortgage Insurance
Buyers putting down less than 20% must pay PMI, an insurance policy that protects the lender if you can’t pay your mortgage. It’s a monthly fee that gets rolled into your mortgage payment. It’s required for all conventional loans that have down payments of less than 20%.
If a buyer can afford to put 20% down right away, they do not have to pay PMI in their mortgage payment, which lowers their payment and gives them excellent home equity from the start.
CONS of Large Down Payments
Delayed home buying
With so many other expenses competing for your money, it can take many years to save enough for a sizeable down payment. Not only does that delay plans of buying your dream home, but it means that you could spend years paying rent for an apartment or house you aren’t building equity in and won’t eventually own.
If you are waiting until you accumulate that big amount of money to start home shopping, you should understand that there are options that allow you to buy now – with little to no money down.
For example, FHA Mortgage Loans are insured by the Federal Housing Administration to protect FHA-approved lenders and minimize their risks. Buyers benefit from lower down payment requirements (typically around 3.5%), lower mortgage insurance premiums, better interest rates, and more liberal credit histories.
FHA 203k Home Renovation Loans simplify home renovations by allowing you to borrow money for both their home purchase and improvement and repair costs using only one loan. In addition, eligible buyers can qualify for a down payment as low as 3.5%. This provides you the best opportunity to build your dream home with minimal money down. Side piece of knowledge, watch this video here to learn how much cheaper mortgage money is than consumer debt.
Less money available for the unexpected
If you drain your life savings for a large home down payment, you’re snatching away your safety net in case an unexpected expense like the car dying, needing a new septic system, a flooded basement, or some other major problem.
Having an emergency fund is a good idea. You should consider holding some of your savings back for these situations while still taking part of that nest egg for a small down payment on their new home. That could create a win-win situation and eliminate some anxiety and stress.
Putting retirement on the back burner
You aren’t going to work forever. At some point, you are going to want to ride off into the sunset that is retirement. But to do that, you need to start socking away money in a retirement fund now. The problem is, if you invest a large amount for a big home down payment, there will be fewer funds for your 401K or IRA. You get the house now, but at the expense of mortgaging part of your future.
So when you consider the size of a down payment, make sure you give your future some thought – and you can always give us a call for a mortgage pre-approval strategy meeting to discuss your options. Saving for retirement is an essential aspect of your financial health, but it takes time, patience, and, well, strategy!
Large home down payments aren’t for everyone, nor should they be looked at as a hurdle to homeownership. Put your mind at ease by making sure you know all the options regarding financing your home purchase and how you could actually benefit from a lower down payment option. This will help save you money, time, and stress.
*Not all borrowers will qualify. Contact us for more information on fees and terms. Not intended as legal, financial, or investment advice. Contact your financial representative for more information.
Crew, K. (2021, February 26). What are the benefits of a 20% down payment? Retrieved March 05, 2021, from https://www.keepingcurrentmatters.com/2021/03/01/what-are-the-benefits-of-a-20-down-payment/