Nowadays, there are options for homeowners to put a minimal down payment towards the purchase of a property. Amounts as little as 5%, 3.5%, and even zero percent have been pretty popular, particularly with first-timers who are trying to break into the housing market for the first time and don’t have the funds from a previous property to put towards another purchase.
But while small down payments are definitely an option, they’re not the best choice if you want to be free of mortgage payments sooner rather than later.
Here are 5 reasons why you should strive to beef up the amount you put towards a down payment on your next home purchase.
1. Boost the Odds of Mortgage Approval
Lenders are a lot more eager to loan money for relatively small mortgage amounts compared to bigger ones, simply because they’re at a much lower risk of being stuck with a mortgage on default. The higher the loan-to-value ratio (LTV), the riskier the mortgage, so anything you can do to reduce the amount of your loan would greatly enhance your chances of your lender approving the loan you apply for.
By offering up a larger down payment and decreasing the loan amount, lenders will stand a better chance of selling the property for more than the amount of the loan if a foreclosure occurs. In addition, the lender will see that you’ve got more incentive to keep up with your mortgage payments if you risk losing your down payment.
2. Save Money on Mortgage Insurance
Mortgage lenders require that Private Mortgage Insurance (PMI) be added to your monthly payments if you put less than 20% down towards a home purchase. That’s because lenders need to protect themselves from the risk of a potential default on the mortgage, which is more likely to happen when loan amounts increase. And depending on the exact loan amount that you take out, you could be looking at quite a hike in payments.
Let’s say you put down 5% towards the purchase of a home. The insurance rate on the subsequent 95% loan amount is .90% for 30% coverage – and that’s only if you’ve got a credit score of at least 760. The percent increases as your credit score decreases. In this scenario, you’d be paying an extra $2,700 per year – or $225 per month – on a $300,000 loan. If you can come up with at least a 20% down payment, you can save that extra cash and keep your payments much lower.
3. Pay Less Interest Overall
The more you borrow against your mortgage, the more overall interest you’ll be stuck paying by the end of the amortization period. Interest payments can add up to hundreds of thousands of dollars in the long haul, which can really have a major effect on your long-term finances.
Let’s say you agreed to buy a home for $300,000 with a 3.5% down payment, or $10,500. That means you’ll be required to take out a mortgage loan for $289,500. If you take out a 30-year, fixed-rate loan with a 3.5% interest rate, you would be obligated to pay about $211,609 in interest over the life of the loan if your monthly payments are $1,200 per month. But with the same terms and a $240,000 loan (after a $60,000 down payment, or 20%), you would pay only about $120,718 – that’s more than $90,000 in savings.
4. Be a More Competitive Buyer
Sellers only want to deal with buyers who are serious about making a hassle-free purchase. The skimpier your down payment, the less favorably you’ll be viewed by the sellers, which will take away from your negotiating powers when it comes time to wheel and deal. And if you’re competing with other interested buyers, your presence will likely be overshadowed by those who come prepared with a beefy down payment.
Bringing a larger down payment amount to the table when putting in an offer will make you a more competitive buyer, which can come in especially handy if you find yourself in a multiple bid situation. The sellers will love it if you can show that you’ve got the funds to make up a really good deal.
5. Protect Against Negative Equity
Plenty of homeowners found out the hard way during the recession eight years ago what a minimal down payment and massive loan amount can do to their equity. While home values in many markets are incredibly strong, that doesn’t mean that they won’t dip from time to time. By having a larger percentage of your property paid off before even getting the keys, you can effectively reduce the odds of getting into a disastrous negative equity situation should the economy or the local market take a temporary downturn.
Of course, it can be a real challenge to come up with a larger amount for a down payment, especially in markets where housing prices are through the roof. But with a little hard work, self-discipline, and some creative tactics that your financial advisor may be able to help you with, you just might be capable of gathering a higher amount more easily than you think.