You can buy a house with a government-backed loan even if you can afford to make a down payment of only 3.5 percent. Some lenders even offer no-down-payment loans. However, the more money you put down, the more you save over the long term. Making a 40 percent down payment means you will save money on mortgage insurance and mortgage payments, and it probably means you can easily qualify for a loan and the most favorable interest rates.
When you apply for a mortgage, lenders typically expect you to make a down payment of at least 20 percent, according to the Federal Reserve Bank of San Francisco. If you cannot afford to make such a large down payment, the lender typically requires you to buy mortgage insurance. If the loan goes into foreclosure, the mortgage insurance covers some of the lender's losses. If you obtain a government-backed Federal Housing Administration loan, you have to continue to pay monthly mortgage insurance premiums for the life of the loan. By making a 40 percent down payment, you avoid having to buy mortgage insurance, which could save you a significant sum over the life of a loan.
Mortgages typically have terms between 15 and 30 years. Every dollar you finance generates interest on an annual basis. If you take out a $100,000, 30-year mortgage at a 5 percent interest rate, you have a monthly principal and interest payment of $536.82, for a total cost of $193,255 . If you reduce the mortgage size by 40 percent, which reduces your loan amount to $60,000, you would have a monthly payment of just $322.09. Over the life of the loan this would mean a total cost of $115,952. Therefore, you pay $40,000 upfront and avoid paying about $77,000 over the life of the loan for a total saving of $37,000.
Debt To Income
The larger your loan amount, the larger your monthly payment. Banks determine how much you can comfortably afford to pay toward the mortgage by calculating your debt-to-income (DTI) ratio. This entails dividing your monthly debt payments by your monthly income. Some lenders are reluctant to lend to people if their DTI ratio exceeds 35 percent, according to the Utah government website. Therefore, making a 40 percent down payment improves the likelihood that your DTI ratio will meet underwriting guidelines.
Despite the benefits in terms of savings when you make a 40 percent down payment, making such a large down payment can have drawbacks. If you spend a large portion of your available cash on your down payment, you may not have the funds necessary to complete home repairs. You can acquire those needed funds by applying for a second mortgage sometime in the future, but second mortgage interest rates may be higher than first mortgage rates, so you end up paying more to borrow when you tap your equity.