10% Down vs. 20% Down On a House
You can use a combination of your own cash and borrowed funds to cover the cost of buying a home. Generally, you have to make some kind of a down payment, and many people make down payments of 10 or even 20 percent of the purchase price. Before you to decide on the size of your down payment, you should consider both the pros and the cons of making a down payment of at least 20 percent.
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Private Mortgage Insurance
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Home prices can both rise and fall, so lenders usually require you to pay for private mortgage insurance (PMI) if you make a down payment of less than 20 percent, according to the Federal Reserve Board website. This insurance policy protects your lender against losses that result if your home goes into foreclosure and sells for less than the balance owed on your mortgage. You have to pay monthly premiums to cover the cost of PMI, and, in many instances, you also have to pay the first year of premiums upfront. If you make a down payment of just 10 percent, you have to pay PMI, but you can eliminate this expense by making a 20 percent down payment.
Loan To Value
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Lenders normally sell first-lien mortgages to government-sponsored enterprises (GSEs) such as Freddie Mac. Freddie Mac and other GSEs have underwriting guidelines lenders must follow that restrict the size of your loan based on the percentage of the market value of your home. As long as you pay for PMI, your loan on your primary home conforms to GSE underwriting standards even if you make a down payment of just 10 percent. However, on non-primary homes, these entities require borrowers to make down payments of at least 20 percent. You can obtain other low-down-payment loans from lenders, but the rates on these loans are higher than on conventional loans. Therefore, you limit your borrowing options when you finance a rental home or secondary home and make a down payment of less than 20 percent.
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Cost Versus Cash
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When you finance a loan, you have to pay interest on the debt until you have paid off the entire loan balance. The larger your down payment, the smaller your mortgage loan amount and the more you save in terms of long-term interest costs. Therefore, you save money in the long term if you put down 20 percent rather than 10 percent.
Aside from making your down payment, you also have to cover the closing costs on your loan. Making a large down payment may mean you lack the cash to cover the closing costs, so a lower down payment may be necessary in this case. Additionally, if you buy an older home, you may benefit from making a small down payment so you have enough cash to fix up your home.
Selling Your Home
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You may regret making a 10 percent down payment if property prices drop and you need to sell your home. You may even find that your mortgage debt exceeds your loan balance. In such a situation, you would have to pay down the excess debt so you could sell your home. Some people argue that you should make a 20 percent down payment on your home so that that falling home prices don't cause you to have negative equity. However, you might lose money either way, because the 20 percent down payment counts for nothing if your home's value drops 20 percent.
Considerations
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You should consider your overall financial situation and your long-term plans when you decide how much to spend on your down payment. A 10 percent down payment means lower upfront costs, but you end up with a higher monthly payment than if you put down 20 percent. If you anticipate a wage increase in the future, a small down payment might make sense to maximize the cash you have available during this lower income period. If you expect your income to drop, you may benefit from minimizing your monthly payment by making a down payment of at least 20 percent.
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