The
Down Payment: More or Less?
The question is:
How much cash should a buyer use as a down payment and
how much of a loan should they apply for?
Well,
there is no straight answer to that question. There are several
factors that affect the down payment, such as the type of loan
you're applying for, your income, your available cash-on-hand,
to name a few. It also depends on your long term goals for the
home you are buying. Here are a few things to think about:
- 20%
Down - Breathe! The benefits to putting 20% down
are fairly straightforward. First, by putting 20% down, you
borrow less which means you repay less. Second, you will
not have to pay private mortgage insurance (PMI) on the loan,
effectively saving you $40 to $70 a month.
- Less
than 20% Down - This is a more common option for first
time buyers. Many loan programs offer buyers the ability to
purchase a home with as little or no money down. This allows
you to conserve your cash for other expenses. The flip-side
to putting less than 20% down is that lenders will require
you to pay private mortgage insurance (PMI). PMI is a monthly
fee that the borrower pays if the loan exceeds 80 percent of
the purchase price. Since a lower down payment results in a
statistically higher risk to the lender, PMI insures a portion
of the loan to reduce the risk to the lender. There are ways
to put less than 20% down and still not have to pay PMI. You'll
want to check with your lender for these options to see if
one is right for you.
- The
Monthly Payment "Comfort Level" - This is
probably the most important issue that will dictate how much
cash you put down. If you have good credit and a solid income,
most lenders will qualify you for a loan amount larger than
you would ever want. Before speaking with a lender, take a
good look at your personal finances and spending habits. Be
sure to include all of your expenses, from the utilities to
dinner and a movie. Then decide just how much you are willing
to pay for a home each month.
- Taxes. It's
important to understand the benefits of mortgage interest and
the real estate tax deduction. Since you will own the home, you
will be able to deduct all the interest and taxes you pay on
the home. Consult a tax expert on these issues, but it's important
to get an idea of how much of a tax break you will receive if
you own the home. This will also help you decide your mortgage
amount.
- Opportunity
costs. Ask yourself this question: What am I giving
up by putting 20% down? If the purchase price of your home
is $200,000, are you going to miss $40,000? What is that money
currently doing? Is it earning a good rate of return? Will
you have to sell securities and pay capital gains taxes to
liquidate that money? Be sure to investigate the true costs
associated with a large down payment.
- Other
debts. Don't forget to consider any other debt you
may have. For example, if you are carrying substantial credit
card debt, it would probably be better to pay the cards off
instead of putting down a large down payment. Or perhaps you
only owe $10,000 on your automobile. It would be better to
pay off the car, and put the difference towards the down payment,
thereby eliminating another expense.
Ultimately, the decision on what amount to put down will be up
to you. Consider this a step in the right direction. There may
be other factors to consider, so think carefully. When in doubt,
talk to friends or relatives that have purchased homes. They may
be able to provide you with additional insight.
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