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Making a Down Payment

There are advantages to making a large down payment. The more cash you put up, the less you borrow and the smaller your monthly mortgage payments. As a general rule, too, the larger the down payment, the better the mortgage loan terms, but the difference in interest rates might not be significant. With a down payment of 20 percent or more, you don’t have to buy private mortgage insurance, saving approximately 2 percent of the amount borrowed at origination, plus one-quarter of 1 percent annually for ten years. A lower mortgage means there will be less stress on the household budget.

For some people, however, a smaller down payment is preferable. Some buyers may not have the extra cash, and others may want to keep a cash reserve for unexpected expenses, household purchases, or investments. The amount of tax-deductible interest expense is greater with a large mortgage, and money not used for the down payment can be invested, even in tax-free municipal bonds.

Typically, a mortgage is the least expensive kind of long-term loan you can get in terms of both interest rate and repayment terms. Also, it is possibly the only type of consumer debt that helps expand one’s credit limit. Therefore, if you have limited cash for a down payment, you should take full advantage of the mortgage loan available—as long as you can afford the monthly payments. You may need to get mortgage insurance, which will add to your costs.

Generally, if you have bought what you expect to be your last house, it’s a good policy to make a large down payment, pay the loan off rapidly, and look forward to the day you no longer have to make mortgage payments. However, if you are transient, perhaps being transferred around the country by your employer on a regular basis, make a small down payment. That way your money is not tied up in your house.

As a general rule, reasons for using a relatively short mortgage loan are consistent with reasons for a large down payment. Similarly, small down payment reasons are consistent with a 30-year mortgage. If you have already decided on a long-term mortgage—to maintain a minimum annual cash outflow or sustained tax deductions—you may have simultaneously answered your down payment size questions.

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