Down Payment Amount: The Facts About How Much You Should Put Down

There are several ways to look at the logic behind how much you should put down on a house you are purchasing.  For most first-time homebuyers, it’s all they can do to scrape together 3 – 5% of the purchase price for their down payment (FHA requires 3.5% down and conventional has programs with as little as 3% down but terms are noticeably better with 5% down).  Hence, this post is more for move-up buyers than first-timers but the concepts and information contained in this post are important for everyone since 1) first-time homebuyers usually become move-up buyers in 3-5 years and 2) the financial concepts that will be discussed are important for everyone to know / understand so that they can be better prepared to plan for their retirement.

Why a Large Down Payment Is Good

I have had some clients who have been in a situation where the only way they can afford the house they wanted was to put amount of money down so that their mortgage would be small enough for them to afford – in some cases, it was about the maximum they could qualify for and in others, it was the maximum they felt comfortable with.  I have had other clients who wanted to get their payment as small as possible so that they had money left at the end of the month to invest (this is going to be a key concept and it’s the reason behind this financial calculator).  Still others didn’t trust themselves to have a bunch of money beyond what they needed to do some renovation and furniture purchases, thinking they would waste it on things that wouldn’t provide long-term value or benefits.  All of these viewpoints have merit, but let’s look at the other side of this coin.

Why a Small Down Payment Is Good

If you have a big chunk of money that you could use as a down payment, it might be smart to consider putting the smallest amount possible down (20% down keeps you from having to pay mortgage insurance so you may want to go that route) and investing the rest.  A bigger mortgage means that you will pay more interest than you would on a smaller mortgage and depending on whether you itemize on your tax returns, that may mean a bigger tax benefit.  The most important thing, however, is the amount of wealth that can be created over time with the money left over after your down payment.  I’ll use an example of a client I had who had $150,000 to put down on the $300,000 home he was purchasing.  After a 20% down payment ($60,000), he had $90,000 left for investing versus the $476.29 (based on average rates as of the time I’m writing this) savings on a $150,000 mortgage that he could then invest every month.  Here are a couple of key things to understand about the two options and why investing $90,000 now is much better than trying to invest $476.29 every month over a 30-year period:

  1. The Time-Value of Money says that a dollar today is worth more than a dollar tomorrow which is why it is important to invest as much as you can as early as you can.
  2. A large some of money provides investing opportunities that aren’t available to someone who can only invest $476.29 per month.
  3. It is unlikely that you will actually invest $476.29 every month for 30 years since you might decide it could be better spent when needs arise such as home repairs, vacations, Christmas and birthdays, and other things that life throws your way.  Conversely, as you watch your wealth grow after investing $90,000 (or some large chunk of money), you probably won’t want to slow that train down by dipping into it – although it’s there if you need it.

If you want to see how much of a difference it makes to invest $90,000 now versus $476.29 every month for 30 years, go here.  This calculation assumes both amounts are invested in exactly the same thing for the same rate of return.  In actuality, however, the $90,000 could make quite a bit more than the smaller monthly investment because of the increased investment options available to investors with larger amounts to invest.

What Types of Investments Are Available?

For someone who is able to invest as little as $50 per month, you can set up automatic investment plans with most companies like Fidelity or TD Ameritrade (among many others) where you can invest in mutual funds in non-retirement and retirement accounts (like Roth IRAs).  For those with large sums to invest, you have options like being able to purchase an investment property, buy stocks and bonds, or trade options (I don’t recommend this unless you study options trading and get to know the various strategies and the associated risks).  Real estate investing provides some great benefits that aren’t available when investing in mutual funds or stocks / bonds.  These benefits include: 1) leverage, 2) depreciation, and 3) tax-deferment.  For more information on real estate investing, including some unique strategies, check out the introductory video in my six-part series on real estate investing:  Top 6 Things to Know When Investing in Real Estate.

So How Much SHOULD You Put Down?

The answer to this question is very personal and, in the end, only you really know.  It’s important that you make an informed decision and that is the purpose of this post and the related information that you will find in the links that I have shared – for you to have lots of great information to make the best decision for you.  You need to be comfortable with the decision and the outcome(s) it will provide (size of the mortgage payment, amount of money for investing or other things, etc.).  I’m am available to discuss your personal situation should you have any questions or just want to strategize.  Feel free to call me at 702-812-1214 or email me at jed.wunderli@noblehomeloans.com.

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