Mortgage Question: Is it Better to Have a Bigger or Smaller Down Payment?

Mortgage loans have been a hot topic in the financial world lately, which is why our last few articles on the Illumination Wealth Blog have been focused on this timely subject. In this particular article, we will actually be talking about a mortgage topic that is more timeless. Whether mortgage rates are high or low, this is a question every home buyer should ask:

Should I put down a smaller down payment?

The Benefits of a Higher Down Payment

At first glance, this seems like a dumb question. The more money you put down toward your home loan, the better—right? There are some clear benefits to having a larger down payment, including:

• Lower Monthly Payments—The total loan amount will be lower and you may also get a lower interest rate. You can also avoid private mortgage insurance (PMI) payments as long as you pay at least 20% of the home’s current appraised value.
• Lower Upfront Fees—Points and other closing costs may be lower when you are willing to put down a larger down payment.
• Paying Down the Principal—The smaller the loan, the easier you will be able to pay down the principal with a higher principal-to-interest ratio in each mortgage payment. Of course, more interest means more tax deductions, as we discussed in last week’s article.

It’s an Investment

However, there are other ways to look at whether or not a larger down payment will be a long-term benefit to you or not. Like any major financial move, you have to look at your down payment as an investment. You are likely not losing any money with a large down payment. It’s going toward a real estate investment that should gain equity. It’s a very low-risk investment that should bring long-term gains.

What Else Could You Do with that Money?

On the other side of the coin, a large down payment reduces your current liquidity. If you put $100,000 down, that’s $100,000 out of your pocket that could be applied towards other higher-yield investments. It’s no secret that real estate—in most cases—is one of the safest long-term investments you can make. Yet, there might be more that you can do with that money to produce even higher financial returns.

Maybe you want to put down 20% to avoid paying PMI, which are essentially wasted payments that you will never get back. You might be able to afford putting 30-40% down. You have the money available or the net returns on your previous home sale provided great equity gains. When you run the numbers, you might actually find that you are better off putting the minimum 20% down rather than applying all that you can afford. That extra 10-20% worth of liquidity may be of more value to you, whether you use it for other necessary short-term expenses or invest it in higher-yield ventures.

Length of Homeownership

Another important factor to consider is how long you plan to live in the home you are buying. If you intend to be there until the mortgage is fully paid off, then it probably makes sense to put down as much money as you can comfortably afford so that you will be able to buy down your principal while minimizing your interest payments over the life of the loan. If you are planning on moving in a few years and this home is just a stepping stone, then a high down payment may not give you any advantage in the long run. You will be paying higher interest rates during those few years in the home, but you will also maintain better liquidity during that time.

Appreciation

Lastly, you also have to look at the projected appreciation, which will be affected by how long you plan to live in the home. Ultimately, real estate is a huge investment that grows as the property value increases over time. You may be able to keep your down payment lower while still gaining excellent equity that more than makes up for that extra money you might have put down at the beginning.

Should I Put Down More or Less?

It’s an interesting question to ask. That’s for sure. Ultimately, you’ll want to weigh all the factors and think out your plan before simply putting down as much as you can. A high down payment may be the right thing to do or it could be a mistake.

It’s always a good idea to talk do your financial advisor when making important financial decisions like buying a home. At Illumination Wealth, we can help you run the numbers, explore the different scenarios and decide what will be best for your short-term and long-term financial futures. Contact us today to schedule a free introductory financial consultation.