How much downpayment should I put on my new home purchase? One of the most common questions from buyers both new and experienced. Let me start by saying that I am not a financial advisor, consider my opinions as just food for thought and do your own due diligence and research. The biggest factor to consider as buyers is affordability of course. Most people don’t want to be house rich, but cash poor at the end of the month when balancing their budget. There are many rules of thumb out there when it comes to how much mortgage you can afford based on your income. Such as your PITI (principal, interest, taxes, and insurance) should not exceed 20-25% of your take-home pay, others say not to exceed 30% of your gross income, and some say simply multiply your gross income by 2, 2.5 or 3 to determine your home budget. However, lenders can and do approve buyers for well above these rule of thumbs. So which is right? It depends.
At the of the day, the goal is to buy a home, but you don’t want to get a mortgage that causes you to stretch your budget EVERY single month for the next 30 years. So it really depends on what works best for your personal budget. As everyone’s situation is different: income, credit, savings, debt, student loans, alimony, etc. There is no one size fits all solution.
The ideal goal in my opinion, however, would be to acquire a mortgage that is at a comfortable level for your budget while at the same time requiring the least amount of down payment out of your pockets. However, if you have more money available to put down to further reduce your monthly mortgage, should you? There is a point of diminishing returns where the amount of money you put down becomes so high yet the reduction in the monthly mortgage payment is hardly worth it. This is true when the interest rate to borrow money is very low. However, if the interest rate is high, then larger down payments start having a bigger impact on monthly mortgage payments.
For conventional loans, when your loan to value ratio is less than 80/20 LTV, lenders will charge you private mortgage insurance (PMI) which protects the lender should you default on your loan. So if you put down less than 20%, you’ll be adding extra costs from PMI on top of your mortgage. So the question becomes, is it worth it to put 20% or more to avoid PMI? Putting 20% down can be a big sum of money depending on your purchase price. Even if you have it available, is it a wise decision? Looking at it from an investment standpoint, it’s a matter of opportunity cost. Assuming you have the full 20% available to put down, you’d be losing the opportunity to put that money to work for you possibly bringing you back even more money in the next 30 years, than you could get by simply losing it as down payment money in an effort to reduce your total mortgage payment and interest paid on the life of the loan. Instead of making a greater down payment, you may want to use your available funds to invest in stocks, real estate, crypto or other investments where the return on interest from the investment is much higher than the home loan interest rate. For example, if you achieved an avg of 8% from your stock investments and your home loan interest rate costs you 4%, you’re still making a positive 4% from the money that you would have used as extra down payment. Hopefully, this information makes sense and gives you a better perspective on how much you should plan to put down for your home purchase. If you should have any questions or need help with your real estate needs, send me a message!