There are a lot of misconceptions about how much money you HAVE to put down when financing a home you’re purchasing. Recently, a young woman named Michelle (not her real name) set an appointment to meet with me about buying a home. She and I had spoken a year prior, just after she had gotten married, but the timing wasn’t right at that time. Could she and her husband have made it happen? Probably, but buying your first home is a big decision and I certainly understand exercising some caution during such a monumental life experience. In our recent get-together, Michelle asked about market conditions and what to expect when she and her husband “eventually saved the $20,000 necessary to put down on a home.”
“The $20,000 necessary?” I asked. “What do you mean $20,000 down? Who told you that you had to have that much money down in order to purchase?” She looked at me like a deer staring at headlights. She had no idea where she’d heard that, but she was sure it was written in stone.
Lender dictates the down
I explained to Michelle that the amount of money you put down on a home varies and that while a lender can dictate the minimum necessary based on your credit score, debt to income ratio, and other factors, ultimately as long as you put down the minimum required by the lender you could pay anything else you wanted. But why would you want to?
Michelle and her husband had $15,000 saved up but it was going to take them another 12 months to save the additional $5,000 they thought they needed. During that next 12 months, it was likely that home prices would continue to rise, and so would interest rates. Waiting could cost them tens of thousands of dollars and hundreds more each month. We had to take action immediately! Michelle called one of my preferred lenders, got qualified for a loan, and happily learned that all she needed to put down was 3% of the purchase price, which translated to exactly $12,000. She could buy now and enjoy lower home prices and a better interest rate!
What exactly is a down payment?
You may already know, but a down payment is the amount of cash you put toward the purchase of a home. This is different from your earnest money deposit, your good faith money, that goes toward your down payment. A down payment is the total amount of money you turn over before close that is not financed by a bank or private party. This is the money you have worked hard and saved.
It may be expressed as a percentage. For instance, it usually takes a 20% down payment to buy a home without private mortgage insurance. It may also be expressed as a dollar amount. As in, you have $25,000 available for a down payment.
Loan programs today allow you to choose almost any down payment you like. There are even zero down payment mortgages for those with amazing credit scores and financial strength.
So, the question most home buyers face right away is, “Should I make a large down payment?” Each buyer should come to their own conclusion. But it’s becoming more popular not to make a large down payment.
Should you make a larger down payment?
Down payments are all about lowering risk for the mortgage lender. Statistically, the more the homebuyer invests up front in the property, the less likely they are to default on the loan. Mortgage lenders like this. For this reason, lenders often offer lower mortgage rates to buyers with higher down payments.
So should you make a larger down payment? There’s nothing wrong with that, as long as you’re not also carrying high-interest debt. You might be better off paying off those balances first.
There are some good reasons for putting less money down on a home. Just because you can put more money down on your home purchase doesn’t mean you should. For one thing, you can’t get your down payment back. The whole point of a down payment is to tie up money in the house. With that money unreachable, lenders say, the homeowner is more likely to make their payments and not walk away from their home when times are tough.
That’s not necessarily a bad thing. Assuming the market continues to remain strong, most homeowners will continue to see appreciation over time, meaning the money is “sitting there” for when they need to sell their home. However, a financial event can leave you wishing you had access to the money without selling. Say you lose a job for two months. An extra $10,000 would be a nice safety cushion.
How much you put down is truly an important decision and I encourage you to speak to both your accountant and Realtor about the decision, then do what is best for you.
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