When purchasing a house, most buyers have to finance the majority of the purchase price with a mortgage. The amount of money you put down upfront determines the size of the mortgage. Knowing how much of a down payment to save up for can be a tough decision. The larger the down payment, the longer you'll have to wait to own a home. However, there are several benefits to waiting to purchase until you have a substantial down payment.
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1. Reduced Mortgage Payments
The more you put down on your home upfront, the smaller the monthly mortgage payments will be. That will help out with your monthly budget but, more importantly, you will save thousands of dollars of interest over the life of the mortgage. For example, on a 30-year mortgage at 5% interest, putting an extra $10,000 into the down payment will save you a total of $9,325 in interest payments. (Exotic mortgages allow you to decide how much to pay. For more see, Choose Your Monthly Mortgage Payments.)
2. Lower Interest Rate
Banks and other mortgage lenders often offer better interest rates when your loan-to-value ratio is lower. An increase in your down payment lowers the ratio and also lowers the risk to the lender. Lower interest rates can also save you significant amounts of money over the life of the mortgage. The interest savings from going from 6.0% to 4.5% on a $200,000 mortgage over five years is $66,863.
3. No Mortgage Insurance Fees
A conventional mortgage usually requires a down payment of 20% of the purchase price of the house. If you want to contribute a smaller down payment, most lenders require that you take out mortgage insurance. This insurance protects the lender in case you become unable to pay your mortgage. There are federal insurance programs available to qualified purchasers and there are also private insurance options. Mortgage insurance can be expensive, ranging from 0.5 to 1% of the house value annually to several thousand dollars per year. The insurance premiums are an extra cost of the mortgage and are not applied to the mortgage balance. (For more, see 6 Reasons To Void Private Mortgage Insurance.)
4. Less Risk When Selling
The real estate market can move up or down after you purchase your house. If the market is in a downswing and you have to sell your house, you may find that your mortgage balance is higher than the value of your home (known as being "upside down" on your mortgage). This situation gives you less flexibility in accepting offers and may make it difficult to sell your home and pay out your mortgage. If you made a substantial down payment when you bought your house, you are less likely to be upside down on the mortgage.
5. Ability to Ride out Financial Crises
No one can ever predict with certainty what can happen in the future. You may encounter a personal financial crisis such as job loss or illness that can impair your ability to pay your bills, including your mortgage. If you have equity in your home due to making a large down payment, you can better weather a financial storm. The mortgage payment will be smaller and you may be able to borrow against the equity if you need to. If you borrowed the maximum possible based on two incomes, you leave yourself open for financial stress and perhaps even foreclosure. (For more, see Too Much Debt For A Mortgage?)
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The Bottom Line
Taking the time to save up money to use as a down payment on your home is a solid investment. It can save you thousands of dollars over the course of the mortgage and can put you on more solid financial footing. (For more, see Mortgages: How Much Can You Afford?)