The thought of having to save money for a down payment to buy a home sends many of us into a panic. Unfortunately, most mortgages require a down payment. How much should you have to pay? Let's explore the pros and cons of paying a large vs. small down payment.
A down payment is a percentage of money required up front to buy a home. The required down payment amount is dependent on the type of mortgage you quality for. FHA only requires a 3.5% down payment. VA mortgage loans are available for no money down, if you qualify. A conventional loan requires 20% down, and for the sake of this article, we will use it as a reference.
Large Down Payment
Although a 20% down payment is a large amount, it eliminates the need for Private Mortgage Insurance (PMI), an additional expense. PMI, required when you put down less than 20%, is designed to protect the lender in the event of a foreclosure. PMI will be attached to your monthly mortgage payment, increasing the amount you pay each month. There are various forms of PMI so it's important to talk to your lender about options. Make it a goal to save 20% for a down payment, if you wish to avoid this additional expense.
Another benefit of a large down payment is the possibility of a lower interest rate from your lender. A lower interest rate will save you a significant amount over the life of the loan. Talk to your lender about getting locked in at a good interest rate.
If you decide to make a larger than required down payment, you will lower the amount you owe on the mortgage and, therefore, lower your monthly payment. Let's say you put 20% down and your monthly payment is $1500. If you increased the down payment to 25%, your monthly payment may be as low as $1350/month, a savings of $150/month. In addition, an offer with a larger down payment may be taken more seriously than one with a smaller down payment.
Paying more down will also save you from paying extra interest on your mortgage. Consider using a mortgage calculator to determine how much interest you'll pay, based off of the amount of your down payment and the cost of the home. On the other hand, the interest is tax deductible so talk to your lender to learn how much you could save at tax time.
If your state requires an earnest money deposit when buying a house, you might want to consider upping the amount of earnest money you put down instead of using the money for a larger down payment. Why? Because in a competitive market, your offer may shine brighter than others. For example, let's say you are expected to provide a $5,000 refundable earnest money deposit but you bump it up to $10,000. When you go up against similar offers, yours will stand out more.
Small Down Payment
Making a small down payment, despite having to pay for PMI, is a good option if you plan to live in the house for a short period of time. For example, if you're going to live in the area to complete a 3-year program then move away, a small down payment makes sense.
A small down payment also leaves you with more money to put towards unexpected home repairs. Owning a home always includes making repairs. If you've paid a small down payment and have a few thousand dollars in savings, you won't be caught in a situation where you cannot afford to replace a hot water heater or fix other unexpected repairs. If you've depleted your savings to pay the full 20% down, you may find yourself in a tough situation when home repairs crop up.
When you are ready to buy a house, take time to consider how much of a down payment you can afford to pay. There are benefits to a large down payment as well as a small one. Only you can determine which option works best for your needs. Discuss options with your real estate agent and your lender then get out there and start looking at homes. You can learn more about down payments and related topics in the following guide: