You’ve decided it’s time to purchase either your first home or make the move to a new one, but there are so many financing options out there it can make your head spin. Some lenders offer 100% financing, others 97%, and the most common is 80% financing. While a low down payment may seem appealing in the beginning, it can often cost you more in the long run. A larger down payment has many benefits such as lower monthly mortgage payments, avoid paying mortgage insurance (PMI), better interest rates, and a lower debt-to-income ratio.
Since the balance of your loan is less, your monthly payment will be smaller when you make a larger down payment. Although you are paying more up front, the extra cost is one time and not spread out through the typical 30-year mortgage. A lot of things can happen during the life of a loan, and it is best to have your payments manageable throughout. Take a $300,000 home purchase for example. If you pay 10% down ($30,000) on a 30-year mortgage at 6% interest your principal and interest payment would be $1,619 per month plus an additional $133 per month for PMI making your total payment $1,752 per month. Considering all the same factors but making a 20% down payment ($60,000), your monthly principal and interest payment would be $1,439 per month. Over the life of a loan the additional monthly obligation can really add up.
In the example above, you notice that the loan with the 10% down payment required an additional $133 per month for private mortgage insurance (PMI). This is a type of mortgage insurance lenders require to be paid if you don’t make a 20% or larger down payment. This protects the lender, not you, if you stop making payments on your loan. The PMI should automatically drop off when you have reached 22% equity in your home. Let that sink in, 22%, not 20%, again, costing you more money than just paying the 20% up front.
The size of the down payment has a direct impact on the interest rate. The larger the down payment, the lower your interest rate will be. A larger down payment means you are less risk to the lender, thus, rewarding you with a lower interest rate.
The more money you put down, the less money you owe, which lowers your overall debt-to-income ratio (DTI). DTI represents how much of your monthly income goes toward paying off your debt. A high DTI is unfavorable to a lender giving you less borrowing power in the future.
If you’re preparing to purchase a new home, contact Stutesman’s Action Realty to make the most of your investment, 417.667.8400.
