Is your down payment too big?

For many people, especially those buying their first home, it may seem as if the larger the down payment they can make, the better. But there’s a point where your deposit could be too large given your financial situation. Before emptying out too much of your savings account, ask yourself the following: Are you going to have enough left over to cover closing costs and moving expenses? Have you retained enough to serve as an emergency cushion in case something in your new home breaks down or your car quits? You may discover you’re better off keeping some of your savings right where it is. 

Start with the minimum
A 20 percent down payment has long been considered the standard when buying a home. Lenders do approve mortgages with smaller upfront payments -- some even offer zero-down loans. But most experts agree that if you can put 20 percent down, you should.

Lenders offer more favorable interest rates to home buyers who make a down payment of at least this size. What’s more, you’re more likely to attract offers from several lenders and to find a mortgage with a good interest rate and the terms you want.

A 20 percent down payment also allows you to avoid added costs. When you borrow more than 80 percent of your home’s value, lenders require you to purchase private mortgage insurance (PMI), which typically costs about half a percent of the loan’s principal -- about $83 per month on a $200,000 mortgage. You can avoid these premiums by putting 10 percent down and getting a second “piggyback” loan for the remainder, but this too comes at a price. A 20 percent down payment sidesteps both of these additional charges.

Determine the maximum
So, should you make a down payment larger than 20 percent? It’s true that every extra dollar you put down reduces your monthly payment and the amount of interest you’ll pay over the life of the loan. But you may be surprised at how the numbers break down.

1. Consider how much interest you will save

Assuming you’re buying a $200,000 home with a 6 percent mortgage amortized over 30 years:

Down Payment

Loan Amount

 Payment  

 Interest Saved

20%

$160,000

$959

-

25%

$150,000

$899

$1584

30%

$140,000

$839

$3168


 

 

 

 

 

 

As you can see, an extra $10,000 down saves you $60 a month, and an additional $20,000 will put $120 a month in your pocket. That sounds great until you consider that it will take almost 14 years for these savings to equal your initial outlay. And the overall interest savings, while significant, will be spread over three decades, amounting to just a few dollars a month.

2. Ask yourself the following questions:

Would you be better off using the money to cover other expenses?
Think about how $10,000 or $20,000 might be put to better use. Settling in to a new home is often more expensive than new owners bargain for. Don’t forget that reputable movers can easily charge over $1,000 -- far more if you’re moving between cities. If you’re purchasing a larger home, you’ll likely need some new furniture. You may decide that the bathroom you thought you could live with needs to be gutted. Paying these costs with cash rather than your credit card can save you a bundle.

Should you keep the funds available in case of an emergency?
You might also want to stash that money in a high-yield savings account - a decision that might one day end up saving your home. If you, or your partner, ever lose your job, this emergency fund will allow you to make your mortgage payments until you’re back on your feet.

Have you retained enough to cover all of the required closing costs?
You will need to set aside a little extra to cover all of the closing costs associated with a mortgage. These will be listed in the Good Faith Estimate of costs that your lender is required to give you within three days of your application.

Will a larger down payment reduce the interest rate of your loan?
There are situations when a down payment larger than 20 percent may be a smart choice. If you have a blemish or two on your credit report, more money down may encourage a lender to give you a better rate.

What is your personal attitude towards debt?
If you’ll have more peace of mind with a smaller loan and more home equity, that’s a personal choice no one should dissuade you from.

Do the terms of your mortgage allow you to make prepayments?
Remember that a large down payment isn’t the only way to reduce your mortgage and increase your equity. Many lenders allow you to make prepayments (extra payments to help you pay your loan off faster) once a year. After you’ve been in your home for a while, if you decide you really do want to knock down your mortgage, this feature will allow you to still do so.

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