When you’re in the process of getting a mortgage , you often need to make a down payment to cover a portion of the purchase price. A down payment is an important part for getting approved, and it can affect your borrowing costs throughout the life of your loan.
Here are the advantages and disadvantages of making a larger down payment on your mortgage.
A bigger down payment helps you minimize borrowing. The more you pay upfront, the smaller your loan. This is beneficial because it creates a cushion to preserve equity in your home even if market values decline. That could make the difference in being able to refinance or sell your home in the years ahead.
Mortgages are priced based on risk. One way mortgage lenders measure risk is through the loan-to-value (LTV) ratio. The smaller your down payment, the higher your LTV ratio is and the riskier your loan appears. Lenders tend to compensate for making riskier loans by charging higher interest rates, so you might be able to qualify for a better rate if you put more money down.
With a smaller mortgage loan balance and mortgage rates, the total interest on your loan will be reduced. An interest rate calculator can show you the total interest you would have to pay so you can see how much the down payment would save you in the long run.
If you put less than 20% down, banks will often require you to pay Private Mortgage Insurance (PMI). This is calculated on your remaining loan balance and it’s typically required for government-backed loans such as FHA and USDA loans. If you put 20% down, you won’t have to pay private mortgage insurance or fees related to low down payments.
By putting a 20% down payment on your loan, you reduce your loan balance, mortgage rate and PMI, which can significantly lower your monthly mortgage payments. Use our mortgage calculator to help you determine what your monthly mortgage payments will be so you can decide whether you can afford to purchase the house.
While there are good reasons to consider a large down payment, you should also be aware of four potential drawbacks.
Saving 20% for a large down payment can take years. For some, it can take decades, and that may not be feasible in your current situation. 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.
Cutting savings to the bone to increase your down payment can backfire, since owning a home often means dealing with unexpected expenses. What if something happens (your car breaks down, health problems arise, and so on)?
Putting all of your free cash into a house It’s critical for homeowners to have a healthy emergency fund in place to deal with home maintenance and repairs. A smaller down payment could allow you to maintain an emergency fund, pay down high-interest debt, or utilize the funds for other goals.
The money you accumulate for a down payment can take away from money you put toward other goals, such as home improvements or your retirement savings. 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.
Think about how long you intend to live in the house. 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 don’t plan to stay in the house long.
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