An increased down payment isn’t always the best strategy for your new home purchase.
As a buyer the common thought is that the more you put down the greater financial sense it makes. There are times when this is the case but in most situations more doesn’t always equal better. With current interest rates still near all-time lows there may be a better use of your down payment funds. There are also tax benefits and other factors you should take into consideration. As long as you put down 20% and avoid the private mortgage insurance (PMI) monthly payment you should explore all of your options before deciding to put more money down. Here are three things to consider with an increased down payment.
Cost of Money. As we mentioned interest rates are still hovering near record lows. The current average thirty year fixed rate is somewhere near 3.5%. The greater the loan amount the bigger the difference is in your payment. On a $500,000 loan at 3.5% the principal and interest is $2,245. On a $400,000 the payment only drops to $1,796. For $100,000 additional down payment there is a savings of $449 a month, which is significant, but probably not worth the down payment. The current interest rate level gives you the opportunity to get a bigger house for a reduced monthly payment. Even with the rate increase for loan size you can still find rates well below 4%. This should be a major consideration when thinking about your down payment amount.
Tax Benefits. A number of buyers have the means to pay all cash for their purchases. At first glance not having any debt on the property seems like an obvious choice. On closer inspection carrying a mortgage may in fact make more sense. With every mortgage there are a handful of significant tax benefits available. For starters a homeowner is allowed to deduct all of the interest paid on their mortgage. They are also deductions for closing costs and repairs. If the property is used as a rental there is another set of deductions you can take advantage of. When you factor in the tax benefits you lower the effective interest rate on your loan and it makes holding some debt a viable option.
Return for Your Capital. Once you close on your purchase it is difficult to pull your down payment money out. There are mortgage programs and options available but they can be just as costly, if not more costly, than your original purchase. It is important to consider if there are better options to park your money. Your additional down payment can be used to pay down existing debt, buy additional properties or invest for a greater return. Some of these options make more sense than others but they at least need to be considered. If putting an extra 10 or 20% down at the purchase leaves you thin on reserves you should at least consider what you would do in a cash crunch. Taking out high interest loans or spending money to refinance can do more harm than good. Think about what gives you the greatest return on your money and make your decision based on that.
Having the ability to put more money down than needed is a good problem to have but still must be addressed. If you are struggling as which option is best seek the council of a local financial planner or money manager. Paying all cash or putting down a large chunk of the purchase price may seem like the best option but is not always the case.