Most people (especially first-time buyers) finance their houses. You’ll be taking a mortgage to purchase that house. Most probably, you’ll be taking a fixed price or adjustable rate mortgage. You’ll be paying the loan over the upcoming years.
An important factor here is the “down payment.”
The loan structure, interest rate, and payment terms are dependent upon this figure. To qualify for a conventional loan, you need to have a down payment of 20% which is also considered the #1 barrier for first-time homeowners. The question is, how much should you pay for the down payment. You can choose 0% down payment programs, or you can pay as much as you like. Some people consider that a high down payment puts you in a better situation, while others think that money is better spent somewhere else.
Let’s see which option is better.
Purpose of a Down Payment
That initial deposit protects the lender. It shows that you have “skin in the game” and you are serious about buying the home. Lenders believe you’re a “risky buyer” if you go for a minimum down payment. The chances are higher that you’ll stop making payments and the lender will have to foreclose the home. Compared to that if you submit a high down payment, you’ll be more careful with payments. You cannot leave the house. It is your asset now.
In that scenario, the down payment is only protecting the lender. If that’s true, homeowners should avoid paying a substantial amount as the initial deposit.
Benefits of Paying a High Down Payment
Interest Rate:
A high down payment makes you a less risky borrower. You are paying more for the house. For the same reason, you might qualify for a low-interest rate.
I have to argue against that. You can get a better interest rate by improving your credit score. A significant down payment helps, but it has a minor effect on interest rates.
Mortgage Insurance:
If you contribute less than 20% for the purchase, you’ll need to pay for the mortgage insurance. It is added to your monthly installment. One benefit of paying more is that you can get rid of the PMI. That’ll automatically reduce your monthly payment.
Debt-to-Income Ratio:
A high down payment often translates into a small monthly fee. Instead of paying a substantial amount each month, you can contribute a small amount, and that’ll be fine. That means, your debt-to-income ratio is reduced. Doing so helps you to focus on other goals. You can focus on other investments. A reduced debt-to-income ratio also enables you to qualify for other loans.
Home Equity Loans
If you submit a down payment higher than 20%, you can choose to get a home equity loan. For example, if you have paid a down payment worth 50% of the property price, you can borrow up to 30% of the home’s value. Property prices tend to appreciate, and you can also earn a profit.
Pros of Sending a Small Down Payment
Buy Sooner than Later
It’s a nice advantage. Saving up thousands of dollars will take years, and that means delaying your goal of becoming a homeowner. However, if you need to submit a few thousand dollars, that’ll make the job easier, and you can buy your home quickly.
Emergency Savings
Never exhaust your savings to buy a home. A good idea is to have at least six salaries in your savings account. Sending a smaller down payment allows you to build a savings account that you can use to pay for insurance, retirement, and investment ventures.
How much should you pay for the down payment?
The answer is a personal choice, but the rule is to save for a down payment, have a savings account, and choose easy monthly installments. Let me share an example. Let’s say; your monthly income is $5,500. You need to put $20k-$30k in your savings account and have the same amount ready as the down payment for your home. Overall, your monthly payments shouldn’t exceed 30% of your income. Until that’s possible, renting should be considered the right choice.
For more information, feel free to contact us.