Deciding on a Down Payment
Just one or two generations ago, you couldn't buy a house without a 20-percent down payment. That meant that many people were effectively locked out of ever owning a home. So the last 20 years have seen major changes in how Americans buy homes. You can now buy a home with 10-, 3-, 1-, or even 0-percent down.
While these smaller down payments have allowed more people than ever to afford home ownership, they (in combination with home equity lines of credit and second mortgages) have made the concept of having a lot of equity in your house — and eventually paying it off — seem old-fashioned.
Here's the thing, though: Not only is a big down payment not old-fashioned, it actually makes great financial sense. You know that paying off your loan in 15 years instead of 30 saves you a bundle of money. In the same way, the larger you can make your down payment, the more you're going to save on interest charges over the life of your loan.
This is because you finance the amount of house that you don't own, and you own all of your down payment. So, if you put $40,000 down on a $200,000 house, you incur finance charges only on your $160,000 mortgage, but if you put zero down, you'll pay much more in interest rates over the life of the loan because you'll incur finance charges on $200,000.
Seeing the Big Picture, Not Just the Monthly Payment
Many people think only in terms of monthly payment, and the truth is, each $1,000 you put down on your house lowers your payment by only a few dollars a month. To really expand your financial opportunities, though, and have lots of options for how you live your life, try seeing beyond the monthly payments to the loan amount itself.
If you can put 20-percent down on a house and pay it off in 10 years by making very aggressive payments each month, in 10 years you'll have way more income than you'll know what to do with! The point is, you'll have options that simply don't exist if you lock in to a 3-percent down, 30-year mortgage.
A Closer Look at Low Down-Payment Mortgages
A common theory is that instead of putting a big down payment into your house, you should put down as little as possible and invest that money instead. Look at this option carefully, though. Most investments don't regularly make more than 6 percent to 8 percent a year, which is what many mortgages charge. Chances are, you'll come out exactly even.
With a low down-payment mortgage, you'll incur a few other costs, too. When you put less than 20-percent down on a house, your lender will collect a portion of your homeowner's insurance and property taxes every month and hold it in escrow (a fancy name for a savings account), and then pay your taxes and insurance directly.
This “convenience” costs you plenty, however, because the bank — not you — earns interest on that escrow account, sometimes as much as a few hundred dollars a year! If you make a larger down payment, or as you build-up equity in your house, you can eliminate that escrow account.
In addition, when you put less than 20-percent down, the lender will probably charge you PMI (private mortgage insurance), which insures the lender against the potential of your defaulting on the mortgage. But what most people don't know is that as you build up equity in your house, you can get your PMI canceled. Ask your lender about its PMI rules.
