Deciding how much down payment to make when buying a home can be a challenge — and it can make a big difference in how much your home costs you. The amount of money you pay upfront determines how much your mortgage payment is. If you can afford to make a down payment that is larger than average on a home, should you do it? Check out the reasons you may want to make a substantial down payment.
1. Easier Approval
Affording a large down payment is a sign of borrower strength and shows lenders that you know how to save. Since this is one of the best indicators of creditworthiness, you are more likely to get approved for a mortgage with a larger down payment. Further, if you are in a multiple-offer situation, offering the seller more money upfront can be the key to outbidding other prospective buyers.
2. A Lower Interest Rate
Banks and lenders usually offer better interest rates when your loan-to-value ratio is lower. An increase in your down payment lowers this ratio and also lowers the lender’s risk. Lower interest rates can save you significant amounts of money over the life of a mortgage. (You can get an idea of how rates affect what you pay over time with this lifetime cost of credit tool.)
The other major factor in lowering your interest rate is your credit score, so make sure you know where you stand before you apply for a loan. You can see two of your credit scores for free every month on Credit.com.
3. Lower Monthly Payments
A bigger down payment means a smaller mortgage amount, which means lower monthly payments. This means more money in your monthly budget for the other facets of your life and again, fewer dollars of interest paid over time.
4. You Can Be Mortgage-Free Sooner
With more of the costs covered at the beginning, you may be more likely to pay the entire mortgage off in less time. With lower monthly payments, maybe you can even make extra principal prepayments. Paying off a mortgage early often makes financial sense and can help you be better prepared for retirement.
5. No Need for Mortgage Insurance
With small (less than 20% of the home price) down payments, lenders usually require that you take out private mortgage insurance (PMI). This protects the lender if you are unable to pay down the line. The premiums are a cost that you avoid by making a large down payment.
6. Protection From Negative Equity
As too many homeowners found out the hard way during the last recession, home values can fall the same way they can rise. By having a greater percentage of your home paid off before you even move in, you minimize the likelihood that a price decline will put you into a negative equity situation.
There are of course, some reasons not to make a larger down payment — you can get a greater return by investing that money elsewhere than you will pay in mortgage insurance and interest or you have other high interest debt. It is important to understand, though, that if you can afford a larger payment or are willing to wait to purchase a home so you can save for one, you may end up paying less for your mortgage overall, paying your mortgage off faster and getting better interest rates and terms in the bargain.
More on Mortgages & Homebuying:
- Why You Should Check Your Credit Before Buying a Home
- How to Find & Choose a Mortgage Lender
- How to Get a Loan Fully Approved