To get a mortgage, you usually need to make a down payment. But how much should you put down? Some loans require little or no down payment, but putting down more than the minimum can be a smart move.
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Why 20% Is a Key Down Payment Amount
Many people target down payments equal to 20% of the cost of the home. Some lenders require 20% down payments as an absolute minimum. But even when lenders are more flexible, there are a couple of reasons why 20% remains a popular figure.
- It helps you avoid paying private mortgage insurance: Typically, lenders will require that you obtain private mortgage insurance if you pay less than 20% in a down payment. The added cost of private mortgage insurance is an incentive to save enough to put 20% down.
- It enables you to get better mortgage terms: Even if a lender will give you a mortgage for less than 20% down, you will often be able to get better interest rates or avoid other fees by making a 20% down payment.
Pros and Cons of Making a Bigger Down Payment
Beyond what lenders require, consider these other factors in deciding how much to pay as a down payment.
- Gives you more equity in your home: More equity means more cushion against falling real-estate values.
- You get a guaranteed rate of return: Putting more money down basically means you're earning a return for that money that is equal to the mortgage interest you're not paying.
- You'll get out of debt faster: If you make a big down payment, you'll have the option of having smaller monthly mortgage payments or paying off your mortgage faster. Getting out of debt years earlier than expected can be of great psychological value.
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- You lose easy access to that money: Putting more down also means you have more money locked up in your home that you'll need to use home equity loans or other strategies to get access to later.
- You could get a better return on your money elsewhere: It makes sense to make your down payment as small as possible if you can earn a better rate of return from investing your money elsewhere. That said, outside investments may not perform as planned. After all, there are no guarantees in the stock market.The risk involved in investing leads many conservative investors to make larger down payments instead.
- You pass up the benefits of tax breaks and historically low interest rates: The costs of carrying a mortgage are cheaper than ever. You may never get another chance to borrow money at terms like we're seeing today -- locking in a low rate for a long period of time. Plus, especially in the early years of carrying a mortgage you get tax breaks on the mortgage interest you pay.
Figuring out how much of a down payment to make can be a tough decision. Using 20% as a starting point makes sense for many would-be home buyers, from which you can adjust higher or lower to meet your individual needs.
The article How Much Down Payment Should I Put Down? originally appeared on Fool.com.
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