It wasn’t long ago that a homebuyer could finance 100% of their new home purchase. In fact, I can still remember cases where the financed amount exceeded 100%, and buyers were able to fund a new home and seven-day vacation in the process.
Those days may be gone, but determining the best down payment remains one of the primary concerns of new homebuyers. Though many aggressive down payment loan programs have fortunately been laid to rest, there are still opportunities for many buyers to purchase a home with little money down. But would you want to? Let’s discuss some of the trade-offs involved with down payments.
To begin, let’s state the obvious: The more cash you have, the better position you are in. If you have the money for a 20% or more down payment, use it. Why? Because in almost every case, your monthly mortgage payment will be lower due to more favorable terms that are awarded to you for putting 20% or more as a down payment.
Now let’s assume that you do not have 20% available. At this point, you actually have several options depending on loan size and occupancy of the property (primary, vacation, or investment home). In some cases, you can put as little down as 3% and in others, you will be required to put no less than 10% down. Furthermore, in an effort to avoid private mortgage insurance (PMI), which is required with less than 20% down, you can consider a 1st & 2nd mortgage (or home equity line of credit), or an option where the lender pays your PMI. (In such a case, your interest rate will be higher). Of course, there is always the option that you, the buyer, pay the monthly PMI yourself. Do not look at this as a poor choice, for it often turns out to be your best path.
Believe it or not, your income is also an important factor in your down payment. This is because a primary qualifier for your mortgage loan approval will be the ratio between your debt and income (DTI). A higher down payment will reduce that DTI because it reduces the monthly payment. Therefore, those with a lower income (relative to the home purchase price) may consider placing a higher down payment (if possible) in an effort to reduce their monthly payment, and, ultimately, their DTI.
In conclusion, there is no “magic formula” for choosing the right down payment. In some cases, more is better; and in others, less is the right choice. The key is being educated on what your options are and how different scenarios can affect your financial and emotional well-being. Therefore, it is imperative that you have a qualified mortgage loan officer at your side who can help you navigate through the complex web of the mortgage process. This is the surest way to choose the down payment that best fits your needs.