by Maurie Backman | Published on Sept. 17, 2021
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Here's why it could pay to make a higher down payment.
When you take out a mortgage, you usually bring some money to the table for a down payment. The amount you need to put down varies by lender. Some lenders require 20% at closing, but many accept 5% or 10%. And there are certain mortgages, like FHA loans, that require even less money at closing.
It may, however, be in your best interest to put more money down on your home, not less. Here are four reasons why.
The more money you put down on your home initially, the less you have to spend in the form of a monthly mortgage payment. That could, in turn, make it easier to work those payments into your budget. Furthermore, if you plan to add expenses to your budget in the future (say, you anticipate having children), a lower mortgage payment gives you more financial flexibility once your circumstances change.
Mortgage lenders make money by charging interest on the sum you borrow to finance your home. The less you borrow, the less you spend on interest. Say you're buying a $400,000 home and you put down 20%, or $80,000. If you take out a 30-year mortgage at 3%, you'll spend $165,688 on interest over your repayment period. But if you put down $100,000 instead of $80,000, you spend $155,333.
Home equity refers to the portion of your home you own outright, and it's calculated by subtracting your mortgage balance from your home's market value. The more equity you accumulate, the more opportunity you have to borrow against your home via a home equity loan or line of credit (HELOC).
If you take out a conventional loan and don't make a 20% down payment on your home, you have to pay private mortgage insurance, or PMI. PMI protects your lender in case you fall behind on your loan payments, and it can easily end up costing up to 1% of your loan amount each year. That means if you have a $300,000 mortgage, you could end up paying an extra $3,000 a year, or $250 per month, to own your home.
To be clear, you don't want to tie up too much money in your home, especially when mortgage rates are competitive, like they are today. In other words, if you're buying a $400,000 home, you may not want to put down 50%, even if you're able to. But it generally pays to put down 20% if you can to avoid PMI. And if you put down a bit more than that, it could result in savings on interest, and more financial flexibility at later points in your life.
Chances are, interest rates won't stay put at multi-decade lows for much longer. That's why taking action today is crucial, whether you're wanting to refinance and cut your mortgage payment or you're ready to pull the trigger on a new home purchase.
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