When we bought our house five years ago, we used a FHA loan. At the time, the down payment requirement was 2.5% (the requirement has since increased to 3.5%). Much as it shames me to admit, we bought with the smallest down payment we could get away with.
Looking back, though, I wish that we had made a bigger down payment when we bought. There are a number of advantages to a bigger down payment:
Lower Interest Rate
Even with our minimal down payment, we still qualified for the best available interest rate. We had gone through an income audit in order to qualify as a self-employed person, and we had excellent credit.
These days, though, a bigger down payment can help you get a better deal on interest. If you pay points, you can get an even better deal. The lower the interest rate, the less you pay over the long haul. A bigger down payment now can mean less money paid during the loan term.
The larger your down payment, the less you borrow. If you borrow less, you pay less in total costs, since the principal you are paying interest on is lower.
On top of that, your smaller loan amount means that you automatically have more equity — or ownership — in your home. This is a good thing. If you end up really needing it, your equity can help you in the long run.
Plus, if you use a 20% down payment, you won’t have to pay private mortgage insurance in a conventional loan. That is yet another way to save money on your mortgage.
Reduce Difficulties When You Sell
One of the big reasons that I wish we had made a bigger down payment is that we wouldn’t be upside down on our home right now. The value of our home has dropped a bit since we bought it (not a surprise). We have about $3,000 negative equity right now. A bigger down payment would have meant that we would still be in the black.
Since we’re not trying to sell right now, it’s not a huge deal. We can easily afford our mortgage payments. However, if you are trying to sell, it can be more of a problem. People who have sold in our neighborhood are selling for $15,000 to $20,000 less than they paid. Those who made large down payments have no problem making the sale and moving on. Even with the need to sell for so little, they still owe less than they are selling for.
Those who didn’t make the big down payment, though, are struggling, since they have to get approval for a short sale, or consider ruining their credit a great deal by walking a way and accepting foreclosure. In a tough market like this, not being able to sell your house can be a big deal, and you have a harder time dropping the price if you didn’t have a big down payment to give you breathing room
Planning ahead, and saving up for a significant down payment is good financial strategy. You save money over time, and you end up with more options.