Conventional wisdom tell us that the bigger the down payment, the lesser we owe the bank.
And therefore, the more equity we have on the house, and the less interest costs we end up paying the greedy money bags.
However, times have changed.
These days, the more you pay upfront, people can actually think that you are forced to do so as you have bad credit.
And with how low interest rates have become since 2008, are we foolish to not get our hands on all that cheap credit?
So strong is this credit trend that many people swear by the wonders of zero down loans!
I do advocate putting down a considerable down payment of at least 20% to avoid PMI.
However, there is a strange but effective technique these days for homeowners to avoid PMI by signing up for it, and later get the house appraised again after remodeling works.
The new increased value can possibly take LTV below 80%, making the borrower eligible to terminate PMI.
At the same time, I cannot ignore the fact that the larger down payment a home buyer puts forward, the smaller and more manageable the monthly mortgage payments become.
But if you are to go overboard with down payment by withdrawing all that money from the time deposits and emergency funds, you could be facing a very bad situation should an event happen which require you to have cash on hand.
The answer to the question of whether you should make the biggest down payment you can afford really depends on your financial situation.
Some questions that might help you uncover the answer to that question includes:
- What is your current financial situation and what would it look like in the near future?
- What are your short and long term savings?
- Why are you saving?
- How much are your emergency funds?
- Do you have other investments with attractive yields?
- Do you have other debt liabilities?
- Do you intend to pay off the home loan as soon as possible?
While the prudent thing to do is to pay more down payment, there are actually various sticky situations where your money can do more magic elsewhere other than helping you save on mortgage interest charges.
For example, if you have credit card debts or other loans that charge a high interest rate, the cash you have on hand would do more good by paying off those debts.
And if you have investment opportunities on the horizon that has a good return on investment (ROI), surely you don’t want to be the one who misses out.
Then there is the kids’ college fund to contend with in a year or two to ponder over.
There are many logical reasons to make just a 20% down payment even though you have enough muscle in the bank account to pay 40%.
But if you are a real estate investor, the answer could be more straight forward.
Leverage is the fundamental principle of investing, especially real estate.
If you are able to employ more leverage, it can dramatically increase your profits when you eventually exit.
For example, if you use a 5% down payment of $10,000 on a property worth $200,000 and sell it 18 months later for $230,000, your ROI is basically 300%. But if you originally went with a 20% down payment, your returns would only be 75%.
While 75% returns is nothing to sneeze at, comparing it with 300% makes it look like David versus Goliath.
In my opinion, investors should always make maximum leverage the goal.
So instead of deciding whether to make as much down payment as they can, investors should be think about whether they can stay afloat by making minimal down payment.
Nevertheless, for regular homeowners and buyers, I strongly suggest to be more pragmatic in your approach.
The more the merrier, as long as it does not compromise your lifestyle and future plans.