This is an updated version of a blog I wrote several years ago.
All too many homebuyers mistakenly believe that they need to put down as much as humanly possible for several reasons: (1) they want to minimize their housing payment; (2) they want to minimize their debt load; (3) they want to avoid PMI; and/or (4) they want to make their offers appear stronger.
We, however, often advise buyers to put down less, and here are the reasons why.
“Cash To Close” Is Much Greater Than Borrowers Expect
“Cash to close” includes the entire down payment, all closing costs, transfer taxes, prepaid interest, property taxes, and insurance.
And the final number is almost always larger than most buyers expect. “Cash to close” is never just the down payment amount, like many borrowers mistakenly believe.
If borrowers are buying in an area with high transfer taxes and if they are setting up an impound or escrow account, “cash to close” can exceed the down payment amount by as much as $25,000 for purchases as small as $500,000.
In any case, borrowers often need to put less down in order to preserve enough extra cash to cover their “cash to close.”
Reserves/Dry Powder/Savings
“Reserves” are the funds remaining in a borrower’s account(s) after a transaction closes.
While required reserves are negligible for most Fannie Mae and FHA loans, they can be substantial for jumbo loans, e.g. 12-month PITI, investment property loans, and for borrowers with multiple properties.
BUT, reserves are not just necessary to meet lending requirements.
New homeowners often need ample reserves for repairs, improvements, furniture, appliances, window coverings, and many other unexpected expenses.
For example, I still remember the angst of some first-time homebuyers who bought a very cute 80-year-old bungalow, and who also had to scrape up $4,000 for some urgent plumbing repairs that surfaced soon after they moved in.
Buyers should also reserve cash for unexpected emergencies, such as a job loss or a medical issue.
Mortgage Debt Over Consumer Debt
Because mortgage debt is spread out over 30 years, because the interest is tax-deductible in most cases, and because mortgage interest rates are usually much lower than consumer debt rates, we almost always advise borrowers to put less down if they have high consumer debt balances, e.g. credit cards, auto loans, student loans, etc.
Borrowers can easily save hundreds of dollars per month by swapping high rate, short-term consumer debt with lower rate, long-term mortgage debt.
Putting Down Less Only Marginally Impacts Payment
In this rate environment, putting down $25,000 less will only increase one’s mortgage payment by $150+ (assuming rates in the mid 6% range).
Every $10,000 added to a loan amount at 6.5% only increases the total payment by $63. And remember, a portion of that increase is tax deductible as well.
Sidebar: Lenders don’t recommend smaller down payments/larger loan amounts to make more money (like someone suggested the last time we published this blog). The additional commission from a slightly larger loan is minimal, and I doubt any lender even considers it.
PMI Is Cheap
This is what I forgot to mention in my previous version of this blog. Borrowers are often desperate to put down 20% to avoid having to pay PMI. But, as I mentioned last month – Why We Love Private Mortgage Insurance (PMI) Now – tough competition and effective regulations have made PMI amazingly inexpensive and much easier to eliminate.
In other words, a little PMI never hurts anyone these days.
Making Offers Seem Stronger
I have seen my wife Heejin talk listing agents into accepting our 3.5% down FHA offers over other offers with as much as 30% down dozens of times.
She does this by touting our airtight pre-approvals, our 5-day appraisals, and our fast closes.
In other words, a strong lender-reputation and a full pre-approval in combination with fast turn-times and a phone call to the listing agent often make a large down payment irrelevant.
