Mortgage down payments - Is bigger better?

The traditional method of buying a home has been to borrow 80% of the home while funding the other 20% with a down payment. For may years, this was more or less a requirement set by lenders; it demonstrated a certain amount of responsibility on the part of the buyer. It also prevented millions of people from owning their own homes. With the median home price in the United States now exceeding $200,000, the average buyer simply doesn’t have $40,000 in cash lying around in order to make such a down payment. Fortunately, lenders have adapted over the years, credit scores and risk modeling have come into play, and most people can buy a home with a far smaller down payment. In some cases, no down payment is even necessary.

But suppose a large down payment is available to you. Should you put a large amount down on a house? What if you can pay cash? Should you do that, or is a low down payment better?

With home prices rising steadily, many Americans have been upgrading their houses. They bought a starter home when they were young, they’ve built equity, and now that they have a family, they would like a larger home. In the meantime, the house has appreciated in value, and selling it would provide a large amount of cash to put down on a new house. Is doing so wise?

There is certainly something to be said for keeping the mortgage as small as possible. No one likes having a 30 year financial burden, and the ability to either pay it off all at once or seriously reduce the term of the loan is an appealing one to many. In addition, money is cheap these days, and a homeowner might have a better place to put his or her money than into their house. The mortgage might represent a 6% loan, but it may be possible to earn more than 6% with the money invested elsewhere. That is one consideration.

Another, perhaps more important, consideration is the availability of other funds for either day to day living or emergencies. Most people don’t save enough and keeping a large sum available in savings or a certificate of deposit might be a smart move for a rainy day. By having less of your available cash invested in your house, you have it to use as necessary for other expenses. Plus, you may find that putting less money down might protect you in ways that you don’t even realize. Lenders make many requirements of buyers that buyers don’t necessarily require of themselves. If you live in a flood-prone area, your lender will probably require you to have Federally insured flood insurance. On the other hand, if you pay cash and your home is fully paid for, you may not think to buy such insurance or you may not wish to spend the money on premiums. Surveys show that up to 60% of Hurricane Katrina victims in the New Orleans area didn’t have flood insurance. You can be that those homeowners who still had outstanding mortgage debts did have it, and they will have their losses covered. Those who didn’t are just out of luck.

In short, it may not be in your best interests to put down any more money than necessary. The interest on the loan is tax deductible, although that is a minor consideration. Keeping your money safe from disaster is a more important thing to consider.