You may be eager to buy a home. But taking time to save a large down payment has numerous advantages.
Most homebuyers have to finance most of the home’s purchase price with a mortgage. The amount you put down upfront determines the size of the mortgage. A conventional mortgage usually requires a down payment of 20% of the purchase price of the house.
Knowing how much of a down payment to save for can be tough. The larger the down payment, the longer it takes to save.
There are, however, several benefits to waiting to purchase until you have enough for a down payment of 20% or more.
1. Reduced mortgage payments
The more you put down on your home upfront, the smaller your mortgage payments will be. That could help your monthly budget. More important, you could save thousands of dollars in interest in the long run. For example, on a 30-year mortgage at 5% interest, putting an extra $10,000 into the down payment will save you $9,325 in interest payments over the life of the loan.
2. Lower interest rate
Lenders often offer better interest rates to borrowers with a lower loan-to-value ratio, or the percentage of the purchase price that you’re financing. An increase in your down payment lowers the ratio and reduces the risk to the lender that you will be unable to pay your full loan balance. Lower interest rates can also save you money over the life of the mortgage.
3. No mortgage-insurance fees
If you want to contribute a smaller down payment than the traditional 20%, most lenders require that you take out mortgage insurance. This insurance protects the lender in case you cannot pay your mortgage. Federal insurance programs are available to qualified purchasers, in addition to private insurance options. Mortgage insurance can be expensive, ranging from 0.5% to 1% of the home’s 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.
4. Less risk when selling
Real-estate values can move up or down after you buy your house. If the market is in a down swing and you have to sell your house, you may find that your mortgage balance is higher than the value of your home. This is known as being “upside down” or “underwater” on your mortgage. This situation gives you less flexibility in accepting offers and may make it difficult to sell your home and pay 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
The future is unpredictable. You may encounter a personal financial crisis, such as job loss or illness, that can impair your ability to pay your mortgage. If you have equity in your home because of making a large down payment, you can better weather a financial storm. The mortgage payment will be smaller, and you could borrow against the equity, if necessary. If you borrowed the maximum possible based on two incomes, you could face financial stress and perhaps even foreclosure.
Taking the time to save money for a down payment on your mortgage 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.