House down payment: Is bigger better?

May 8, 2012 6:17 AM

House down payment: How much is best in the current economy?

We're in a position to comfortably make more than a 20% down payment on a house (it wouldn't wipe out our savings, and we'd have enough left for renovations, emergencies, etc.). I think that in the past the advice was to put the minimum down and just invest the rest, but my (naïve) number-crunching makes it look like we'd be better off putting more into the house up front these days. Is there a general consensus on the best approach in the current market? (It would be a standard 30 year mortgage, probably ~4% interest, fixed-rate). Lower monthly payments are also appealing for a variety of reasons.

(I've seen previously and previously, but those posters both seemed like they were choosing between putting more down or keeping some buffer money, and we should be able to do both.)

Thanks!

posted by svenx to work & money (13 answers total)

If you put down 20% you can avoid paying PMI, so that should be taken into consideration. FWIW, I have always put at least that amount down for that one purpose.
posted by murrey at 6:29 AM on May 8, 2012 [1 favorite]

I think that in the past the advice was to put the minimum down and just invest the rest

If you're going to do that, you'd be better off renting.
posted by empath at 6:36 AM on May 8, 2012

Lower monthly payments are also appealing for a variety of reasons.

The higher the down payment, the lower the monthly payments. The lower the monthly payments, the easier it is to make extra principal-only payments or twice-monthly payments, both of which cut significantly the interest you pay over the life of the loan.
posted by headnsouth at 6:45 AM on May 8, 2012 [1 favorite]

I think it would depend on how long you expect to stay in the house. Over the span of just a few years, it's not likely that you can invest extra money safely at a rate of return that will beat what you're paying in interest on the loan, so you may as well throw as much as you can at the mortgage. However if you were to stay in the house for a long time and interest rates were to return to something like their historical averages, you might be better off investing elsewhere.
posted by jon1270 at 6:51 AM on May 8, 2012 [1 favorite]

I would not consider buying without being able to put 75% of the purchase price in cash.

That's not realistic for many people, particularly those looking for a first home. I've got no equity right now, and even getting to 20% would take some doing. 75% is simply not gonna happen.

I think a better idea than paying more up front would be to put 20% down but get a 15- or 20-year mortgage instead of a 30-year. This means lower interest rates, which is no bad thing. True, your monthly payments would go up, but you could use the money you would have used to pay more than 20% to defray those costs. In the mean time, you'd have a bunch of liquid cash you could use for emergencies, etc. Cash is hard to come by, and tying all of your cash up in non-liquid assets is usually unwise, even if having cash costs you money in terms of opportunity cost.
posted by valkyryn at 6:55 AM on May 8, 2012 [2 favorites]

I think that in the past the advice was to put the minimum down and just invest the rest, but my (naïve) number-crunching makes it look like we'd be better off putting more into the house up front these days.

Right about now, putting extra down on your mortgage will earn you an implicit 4% or so. Putting extra down makes sense if you think you cannot earn more than 4% on that money anywhere else.
posted by ROU_Xenophobe at 7:02 AM on May 8, 2012 [4 favorites]

The higher the down payment, the lower the monthly payments. The lower the monthly payments, the easier it is to make extra principal-only payments or twice-monthly payments, both of which cut significantly the interest you pay over the life of the loan.

This is also a good argument for getting a 30 year mortgage and paying more when you can, as opposed to being forced to by a 15 year. With interest rates as low as they are, the discount for a 15 year mortgage is barely worth it. Especially if this is going to be your home for a while. Paying just a little extra every month reduces the amount of total interest pretty quickly, and cuts down the number of payments.

I would put down the 20% and leave the rest of the cash liquid. That can mean that you are "losing" the implicit 4% gain, but that can get eaten up very quickly if you have to get some other kind of loan to cover an unexpected cost that you otherwise would have been able to pay with your savings.
posted by gjc at 7:09 AM on May 8, 2012 [4 favorites]

ROU-Xenophobe gets to the crux of it, I think. Are you aware of some investment that guarantees you more than 4%? Maybe the old strategy took into account the old saw about the market returning 8% over the long haul, but that's over the long haul, and historical, hardly guaranteed.
posted by troywestfield at 8:06 AM on May 8, 2012 [1 favorite]

Putting less down upfront only makes sense if you can reinvest that money at a higher rate than the Interest Rate you are paying on the Loan. (+ in the USA a little to make up for the interest Tax Deductions - do you get that in Chicago?)

Current rates on cash deposits in the USA are below 4% . So unless you want to look into something with higher risk (i.e. shares ) there is little chance you will better that 4%.

I'd put down as much as is feasible for you and ensure that the mortgage you sign doesn't have penalties for early repayments / additional principal repayments.

At the moment some cash interest rates are actually less than the CPI which means that if just leave that extra money in an account it will be slowly losing relative value over time.
posted by mary8nne at 8:15 AM on May 8, 2012

Buying a home is both an investment and very emotional.

You will get better interest rates, not pay PMI and have instant equity if you put down 20%. In fact, if you CAN'T put down 20%, you shouldn't be buying a home. (I SO wish someone had beat that into me when we bought our house.)

Technically, if you were very savvy financially, you could invest the money and make more on it, but that's a huge IF.

What do you lose by putting the money into your house? Money. What do you lose if you don't? Money and peace of mind.

If something happens, and you need to sell and move, having the equity will help. Being able to refinance will help. Having a low mortgage and non-existant PMI rate will help.

You are in the rare position to make a significant investment in your house and have money in the bank afterwards.

Congratulations!
posted by Ruthless Bunny at 8:29 AM on May 8, 2012 [1 favorite]

The case for putting down just enough to avoid paying PMI is that you can then better diversify your investments and keep more money liquid.

Once your money is invested in your house via a bigger down payment, you can't easily get that money back if you need it for something else, like if you have a medical emergency or lose a job. That's especially true if you lose a job, since a bank won't give you a cash out refi on the basis of your equity, they're doing it on the basis of your income.

And regarding diversity, if the housing market sags generally, or if the market in your neighborhood or town gets depressed, or specifically if the value of your house declines because the house next door is a crack house, or a parcel across the street gets zoned commercial, or whatever. So just as if you were purely a stock investor and wouldn't invest all of your money in one particular stock or sector of the market, you are best served by not investing all of your money in one particular real estate asset.

And the low interest rate on the mortgage means that you're not getting a huge reward in theoretical investment yield, since the difference between the 4% "yield" you get by having a bigger down payment and what you might get in other investments probably won't be too great.

Not to mention, if you go and spend the savings each month from the lower mortgage payment on anything other than some kind of investment, you'll have less in the end. So if you do decided to put more money down, you might also want to consider making an automatic payment each month into a mutual fund. (This is because the "investment" return of 4% is actually realized by a smaller mortgage payment each month).

For people who already have a substantial amount of other investments and plenty of liquidity, it makes more sense to make a huge down payment. But for people who would be tying up the vast bulk of their money into a single asset, it makes less sense.
posted by MoonOrb at 8:37 AM on May 8, 2012

This really depends on how long you plan on being there. If you're going to be there more than 20 years and/or it's unlikely you'll need to access the extra funds during that period, put 20% down and put the rest into an index fund. The less time you plan on being there and the stable you need the balance to be, the less tolerance for risk you have.

To get more than the slightly-less-than 4% return you need to justify a lower down payment, you'll need to take on some risk but you'll almost certainly be able to find a fund (likely some flavor of bond or stable value fund) that will return something in the 5-6% range and not fluctuate too much.

The other thing to consider is that, by putting less money down, you're signing up for a higher payment. If your income is nice and stable, it's highly unlikely that will change, and the payment at 20% down is plenty comfortable for you, than you'll be fine. What are the odds you or your SO will lose your job? Can you still afford the mortgage at 20% if you do? Would you need to draw on the money that you invested in lieu of a down payment?

One last thing to consider is that extra money put into a down payment gets you some extra equity out of the gate but that equity isn't very liquid. To access it, you would have to either sell your house (which isn't exactly a quick process) or take out a 2nd mortgage. The 2nd mortgage is fast and rates on those are pretty low right now but what happens if, five years from now, you lose your job and run out of savings? You can take out a home equity line of credit but nobody knows what the rates will be like in five years. If we somehow start on a much faster economic recovery and inflation starts to be a concern, rates might be up to 10% while your investment might have gained value along with the economy. With the higher down payment, you're also kind of putting all of your eggs in one basket (your house) investment portfolio wise.

Personally, I'm in the put-down-20%-and-invest-the-rest camp.
posted by VTX at 8:42 AM on May 8, 2012

Once your money is invested in your house via a bigger down payment, you can't easily get that money back if you need it for something else, like if you have a medical emergency or lose a job.

The above is why this:

Putting less down upfront only makes sense if you can reinvest that money at a higher rate than the Interest Rate you are paying on the Loan.

...isn't true. The equation isn't just "Can I make more money than I'd save paying interest?" It's also "Is borrowing money here cheaper than borrowing money--or doing without--for something like a medical emergency or new car?" The answer to the first one is, "Maybe. Probably even." The answer to the latter is almost certainly, "No." Mortgages are about as cheap as loans come, as they're by definition secured loans. If you have to borrow money to buy or replace a car, you're gonna be lucky if you can get away with twice the interest you're paying on your house. So you should probably discount any money you save by pre-paying your mortgage by some factor that reflects the admittedly intangible value of having cash on hand.
posted by valkyryn at 8:58 AM on May 8, 2012 [1 favorite]