A conventional down payment on a home is 20 percent of the overall cost of the home. So if you’re buying a $250,000 home, you’d have to put down $50,000 up front. Many people deter from buying a home because of the large down payment lenders use to require. Today, many lenders are accepting down payments much lower, some even as low as three percent. Even if you can afford it, should you put down 20 percent?
Con: Higher Rates
Unlike the old days when mortgage pricing was standard for everyone, lenders today, will use risk-based pricing adjustments. They will produce the rate of your loan by factoring in the type of loan for you take (fixed or adjustable), the size of the loan, the size of your down payment, amongst other things. These factors can both raise and lower your rate, for example, a high credit score will help lower your rate. This is also true for your down payment, higher the down payment the lower the mortgage rate. This is because applicants who put down smaller payments are deemed higher risk than those who put down 20.
Con: Higher Closing Costs
Along with having a higher mortgage rate you’ll experience higher closing costs. You’ll have high closing costs because certain closing costs are based on the size of your mortgage, therefore putting down less will mean you’ll have a bigger mortgage making your closing costs commensurately higher. Depending on where you live, some places have mortgage stamps, which will also be higher with a smaller down payment. This is not much of a factor if you live in a place where the seller typically pays the buyer’s closing cost.
Pro: More money left over for closing costs
While closing costs do depend on your lender, the less you put down on a home the more you’ll have left over for your closing and other costs. Using the example of buying a $200,000 home with a 10-percent down payment of $20,000, when you add in closing costs and the cash reserves (money some banks require you to have on hand after the home purchase), the total money you need to close came to $31,000. If putting down 20 percent is already hard enough, the additional costs may mean you have to put down less.
Pro: Put down less and invest the rest
If you don’t put down the full 20 percent, then what are you going to do with leftover money? Invest it! Statistically, the stock market has returned about 10 percent per year since 1928 based on a performance of the S&P 500. If you’re planning to purchase a $250,000 home and decide to put five percent down ($12,500) instead of 20 ($50,000), you’ll be left with $37,500. A 10 percent average annual return on $37,500 would be $3,750 in annual investment income.
Renting a home over a five-year course is more expensive than buying, so you should do whatever makes sense for you financially. If you can’t afford 20 percent, then go with a lower down payment.