When you buy a house, should your down payment be as high as you can afford? Not necessarily. There are several reasons why you should pay a lower down payment on your home.
Reason to Lower Your Down Payment #1: Opportunity Costs
The first, and arguably most important, reason to avoid doing a large down payment is opportunity costs. To make the argument, let’s look at a few examples.
Example 1: Your down payment is $50,000, effectively lowering the monthly payment on your 3.5% mortgage. At 3.5%, you’re saving yourself about $1,750 per year.
Example 2: You put $0 down, so you’re paying that $1,750 of additional interest every year. But you take the $50,000 in cash and invest it in the stock market. To be conservative, let’s say you make 7% on your money. That means you’re making $3,500.
Not only that, but your money will compound. So over the next 30 years, it will continue to grow and pay out much more than the additional $1,750 you’re paying in interest each year.
Yes, it is a little muddier than this. For example if you sell your stocks, you’ll need to pay a capital gains tax. Yes, you can deduct interest paid on your mortgage from your taxes. But at the end of the day, you’ll usually come out further ahead by investing your money than paying a big down payment.
Reason #2 to Pay a Lower Down Payment: Home Improvements
Have you ever moved into a new home and been perfectly happy with it? All of the paint colors, appliances, carpet, etc.? If you’re like most people, probably not.
Keeping a few thousand dollars in the bank lets you pay for home improvements without charging up your credit card. If your credit card interest rate is 18% and your mortgage is only 3.5%, it’s clearly a better option to avoid charging up the card.
That’s why it’s important to identify things you’ll want to improve before you buy the home. If you know the backyard will need an overhaul, look into the expected costs for that. Does the dishwasher look like it’s older than you are? Put money aside for it.
Even if nothing stands out to you right now, we recommend keeping at least $1,000 on the side. Once you move in, you’ll see the house differently and may decide to update a few things after all.
Reason to Lower Your Down Payment #3: Rainy Day Expenses
Let’s face it- we don’t always know what is going to happen. Your water heater gives out and the basement is flooded. The upstairs air conditioner breaks in May – just as the summer is heating up. Your backyard has an erosion problem that becomes evident after the first rain storm.
If you have some money put away to cover these emergencies, you’re ahead of most Americans. But if you used up all of your cash on the down payment, you’re out of luck and will need to charge up your credit card. Not good.
So lower your down payment a bit and keep cash aside for when these rainy days come.
For more personalized advice on your down payment and overall home buying experience, give us a call at (949) 651-6300. We look forward to hearing from you.
Courtesy of Cuselleration
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