Pros and Cons of Using A Larger Down Payment

When you buy a home, some financial experts recommend making the largest down payment possible, while others suggest financing as much of your purchase as possible. The right answer depends on market conditions and your circumstances.

The biggest obstacle to first-time homebuyers is coming up with money for a down payment and closing costs (usually an extra 1-3% of purchase price). So, doesn't it make sense to lower this hurdle as much as possible by minimizing the down payment?

Maybe, but there are also several benefits to a larger down payment. Here are five advantages:

1. Smaller mortgage loan balance: A larger down payment means starting out with a smaller loan balance, which has a few advantages. One of these is that it creates a cushion to preserve equity in your home even if market values decline. That will make the difference in being able to refinance or sell your home in the years ahead.

2. Less interest expense: Making loan balances smaller will save you interest over the term of the mortgage. A mortgage calculator can show you the total interest you would have to pay so you can see how much a larger down payment would save you in the long run.

3. Reduced mortgage insurance premiums: Mortgage insurance covers the risk of borrowers not repaying their loans. Since this risk is greater for mortgage loans with higher LTV ratios, the size of your down payment will affect how much mortgage insurance you have to pay, how long you have to pay it, and the amount of your premiums.

4. Positive budgeting experience: Saving for a down payment may be challenging, but it will also allow you to practice the budget habits you will need in order to make your ongoing mortgage payments. Too many homeowners learn only once they take on those monthly mortgage payments just how much of a strain they put on a budget. Think of saving for a down payment as a trial run for when it comes time to making mortgage payments, you will be well disciplined. This discipline is a must when it comes to staying on top of not only your mortgage payments, but all debts.

5. More manageable monthly payments: A number of the above factors - reducing your loan balance and mortgage insurance premium - can contribute to making your monthly payments lower. This is another good use for a mortgage calculator - it can show you how much less of a burden your monthly payments will be if you start off with a larger down payment.

While there are good reasons to consider a large down payment, you should also be aware of potential drawbacks. Here are some disadvantages of a large down payment.

1. Longer time to enter the market: The months or years spent saving for a large down payment can delay your readiness to buy a house. This means paying rent for that extra time, and if housing prices are rising rapidly in your area, it could result in prices getting away from you.

2. Less short-term flexibility: Cutting savings to the bone to increase your down payment can backfire, since owning a home often means dealing with unexpected expenses. A smaller down payment could allow you to maintain an emergency fund, pay down high-interest debt, or utilize the funds for other goals. However, making a smaller down payment should not be an approach to buy a home you can't afford.

3. Interference with retirement saving: Money you accumulate for a down payment can take away from money you put toward other goals. For example, you may have to cash in some long-term investments to come up with a down payment, or putting aside money for a home might restrict your retirement. Whenever you look at the benefits of a large down payment, you should also take into account the opportunity cost of diverting that money from other things.

4. Benefits take a while to add up: Many of the benefits of a large down payment reward you more in the long-term than in the short-term, which may not be much use to you if you do not plan to stay in the house for a long period. If you plan to leave in a few years it may not make sense to put in a lot of extra cash.

A side note to keep in mind: for borrowers that can afford to put a down payment of 20% or more, the interest rate will always be higher than the interest rate for borrowers that put less than 20% down. For further details on this, feel free to connect with me.

The pros and cons of a large down payment encompass a number of factors, including your local real estate market, your financial situation and your long-term goals. Once you understand whether a large down payment makes sense for you, the next step is to figure out how to come up with the money you need.