If you have the money to make a large down payment, you may think that it’s automatically the right thing to do. This way you can have a lower payment and own your home faster. While that might be true, there are good and bad sides to making that large down payment.
Keep reading to learn if you should or shouldn’t put a lot of money down on a home.
The Benefits of Making a Large Down Payment
First, we’ll look at the ‘good side’ of making a large down payment, as there are many.
- You’ll have a lower mortgage payment. Even if you keep the same term, say a 30-year term, you will owe less, which will make your monthly payment lower This can decrease the stress that can come along with a high mortgage payment.
- You’ll pay less interest. There are a few reasons that you’ll pay less interest when you make a large down payment. First, your lender will likely give you a lower interest rate because you have a lower loan-to-value ratio. Second, you have a lower balance to pay interest on, which will decrease the actual cost of borrowing money to buy a home.
- You may avoid PMI. If you’ve heard of the 20% down payment rule, you are familiar with PMI. If your large down payment is at least 20% of the home’s purchase price, you can avoid paying PMI on a conventional loan. You should know, though, if you take a government loan, such as the FHA loan, you will pay mortgage insurance no matter what your LTV is on the loan.
- You have equity in the home right off the bat. This means that if you ever do get into a bind and need cash, you may be able to tap into your home’s equity. If you don’t touch it, though, you may realize a much larger gain when you do sell the home.
The Drawbacks of Making a Large Down Payment
As with most things, there is a good and bad side to making a large down payment. Keep reading to learn some of the bad sides that you may realize.
- You may deplete your emergency savings. Even though you have significant equity in the home when you make a large down payment, you deplete your immediate liquidity. What if something happens and you don’t have the cash to cover it? While you can refinance to tap into your equity, it doesn’t happen overnight and there’s no guarantee that you will get approved.
- You may take away from other investments. If you don’t have retirement savings or you don’t invest elsewhere, you may be putting all of your eggs in one basket. Forgoing 401K investments, for example, is like giving away free money if your employer matches your contributions. Even if you don’t have a matching 401K, you could have other investment possibilities that you overlook because of your investment in the home.
- You only benefit if you stay in the home long-term. If this is a short-term purchase for you, it doesn’t make sense to put all of your money into it. You won’t see much of a return on your investment in the short-term, which goes right back to the missed opportunities for other investments.
Does this mean that you shouldn’t make a large down payment on a home? It really depends. Ask yourself the following questions to figure out the answer for your own situation:
- How long do you plan to stay in the home?
- Do you have money invested elsewhere?
- Do you have money set aside for emergencies? Typically, six to nine months of income is sufficient.
- What are your plans for the future? Do you see yourself going down to one income or making any major improvements that will require a large amount of cash?
The answers to these questions should help you make a thoughtful decision. You can then talk to your lender about your various options. You may find that putting down an extra $10,000 down now only saves you a few dollars each month on your mortgage payment. At that point, you may decide that it’s not worth it. If you find that the savings are great, though, it may encourage you to do so to further your investment in your home.