Staying on Budget with down payment
Maximizing a home down payment can make sense: the bigger the down payment, the lower the monthly mortgage bill and the better the chance of building equity more quickly.
But putting too much down could leave you without enough cash for home maintenance – or anything else.
Pinpointing the right amount involves balancing the advantages of boosting the down payment against the need to hold back money for urgent upgrades, life’s emergencies, and having some fun with your new home.
There’s no one-size-fits-all model – each situation requires it’s own unique blueprint.
Higher down payment
Calculating how different down payments would affect a monthly mortgage payment is eye-opening. Lenders may require only 3% down for conventional home loans, which makes getting in the door easier, but means assuming more debt than with higher down payments.
Many borrowers ask if they should scrape together a little more, such as 5% versus 3% — or 10% versus 5%. But that probably wouldn’t make enough difference in the monthly mortgage payment to justify doing so if it left you strapped for extra cash.
Moreover, the need for post-closing cash is always greater, and sometimes significantly so, than people expect.
To that end, a higher down payment can make a difference if it means lowering or avoiding mortgage insurance.
What is mortgage insurance? The mortgage insurance, which can involve upfront and monthly fees, protects the lender if the borrower defaults and is required if the borrower puts less than twenty percent down.
Depending on the type of loan, making a higher down payment may eliminate some of that expense, if not all of it.
Many clients of mine cannot put down the traditional 20%, but they want to put down more than the minimum when they buy a home. I say: ten percent is a good compromise.
Why? Because they will be able to eliminate private mortgage insurance more quickly than if they put three of five percent down.
Or, put down only three to five percent and make extra payments each year – there is no pre-payment penalty in doing so!
Borrow with care
When deciding on down payment size, consider its effect on other aspects of your financial plan.
Twenty-nine percent of homeowners’ ages 21 to 34 borrowed from retirement accounts to help fund the down payments.
Keep in mind that the decision to do so shouldn’t be taken lightly. Borrowing from a 401(k) is particularly risky.
After a job loss, the loan must be repaid by the next tax filing deadline or it’s taxed as ordinary income, with a 10% penalty if the withdrawal is taken before age 59½.
Using a Roth IRA to boost a down payment is a better option.
There are taxes or penalties on withdrawals of contributions. First-time home-buyers who have contributed to a Roth for at least five years can withdraw up to $10,000 of earnings on the contributions, tax and penalty-free.
I do not recommend borrowing from retirement savings unless necessary. Many people are behind on saving any way, and borrowing from an IRA means losing true-free growth.
Expect the unexpected
Thirty-four percent of recent first-time buyers say they no longer felt financially secure after buying their current home.
To maintain security, resist draining your savings for the down payment and closing costs. Leave some for emergencies, such as a car breakdown. Emergency reserves are for ‘Oh, sh**’ moments, and homeownership includes plenty of those.
To minimize surprises, review the home inspector’s report and negotiate repairs with the seller before purchasing.
Budget for immediate upgrades, such as fencing the yard for your dog, and always include some cushion.
Finally, leave some cash for fun stuff, like furniture. You have just made a major purchase – your first home! – so you’re going to spend money because you’ll have rooms you didn’t have before.
Happy house-hunting, and call me if you have questions about down payment or anything else related to home financing!
Thanks for reading!