Ask Money

How much of a down payment?

Chris Farrell Sep 22, 2009

Question: I am buying my first home. I’ve been a diligent saver, and have enough for 20% of the down payment. I wonder what the drawback is to putting down more than the required 20%. I can put down between 30 and 40% of the purchase price, without interfering with my 1.5 year living expenses safety fund or my retirement accounts. I have no debt. I’m attracted to having lower payments and paying less interest in the long term, and plan to be in the house for more than 10 years. What are the drawbacks to putting down a larger amount for a house, if you already have a safety fund, no debt, and a retirement account? Andrea, Durham, NC

Answer: You sure are a diligent saver. It’s really nice to take a question from someone in such terrific financial circumstances. Since you’re a first time homebuyer remember to take advantage of the $8,000 tax credit (assuming you qualify). Also, you want to make sure that there is no prepayment penalty with the mortgage loan. In other words, you don’t want to pay a fee to the bank if you end up paying off the mortgage early. I have a feeling that’s what you’ll do, too. My bottom line: You can’t go wrong if you put 20% down or 40%. There isn’t any real drawback to the larger down payment.

That said, there are two traditional trade-offs for you to consider: In return for a smaller mortgage and less interest payments you could give up 1) some financial flexibility and 2) some potential diversification. (A lot of people will say you’re also reducing tax benefits from the mortgage interest deduction. But I think the cost of interest payments and the extra financial security swamps the tax gain.)

Here’s what I mean: When you make a 20% to 25% (instead of 30% to 40%) you have more savings readily available to you to fund an investment opportunity, to pay for a career shift, to embark on an adventure or to withstand a severe setback. What’s more, the cost of owning, furnishing, and maintaining a home is often more than renters anticipate. So the 20% down payment leaves you a larger cushion while you adapt to homeownership. Of course, you can always borrow the money from your home equity. But why take on debt when you can tap savings? You can always accelerate your mortgage payments and pay off the mortgage early.

Second, with a bigger down payment you tie more of your savings to the performance of one asset–a home.

You’ll play with the numbers, but I wonder if this might be a good financial compromise for you? What if you put 30% down instead of 40%? You get benefits of a larger than normal down payment, but you also keep your savings flush while you learn the ins-and-outs of homeownership. And then if you still are flush, I’d pay off the mortgage on an accelerated schedule and save yourself thousands and thousands of dollars in interest payments.

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