Three Important Factors You Need To Know Before Making A 20% Mortgage Down Payment.
What Is A Down Payment?
A down payment is the amount of cash you put toward the purchase of a home. Three Important Factors On Making A 20% Down Payment. NSH Mortgage has the wisdom and tools to help to discover what is needed on making any down payment.
It is expressed as a percentage. For instance, $40,000 down on a home costing $200,000 is equal to a 20% down payment.
Loan programs today allow you to decide on almost any down payment you would like, even 0%. Incidentally, the question most home buyers face right away is, “Should I make a large down payment?” Each buyer should come to their own conclusion. But it is becoming more popular not to make a large down payment, for several reasons.
Why Are Down Payments Sometimes Required?
Down payments are all about lowering risk for the bank. The theory goes, if the home buyer has more of their own cash invested in the property, they are less likely to default on the loan. This theory is flawed.
VA loans, for instance, require zero down, yet they have at least one of the lowest default rates of any loan type. Actually, low default rates may not be caused by the high down payment itself. Those who have access to a large down payment are likely also more financially stable and firmly planted in their careers.
Their high down payment may have nothing to do with the fact that they did not default. Therefore, while you might hear that it is more conservative to create a large down payment, it is only partly true, but it is more conservative for the lending institution. A large down payment is actually riskier for the home buyer.
Should You Make A Large Down Payment?
There is nothing wrong with making a large down payment. Those who can do so without depleting all their assets perhaps should. A large down payment helps you afford more house with the same payment.
Even though a large down payment can help you afford more, by no means should a home buyer use their last dollar to stretch their down payment level. It is not conservative at all, for the following three reasons.
1. You Cannot Get Your 20% Down Payment Back That Easily
The whole point of a down payment is to tie up money in the house. With that money unreachable, lenders say, the homeowner will continue to make their payments. That is not necessarily a bad thing. The money is waiting there for when you eventually do sell the house someday.
However, with any financial events, they can leave you wishing you had access to the money without selling. Say you lose a job for three months. An extra $20,000 would be a nice safety cushion.
On the other hand, if you lose your source of income, you cannot take home equity out through a cash-out refinance or home equity line of credit (HELOC). Lenders will not approve a new loan to someone between jobs. In short, the more you need to get at the money, the less access you have to it.
2. You Are At Risk When Home Values Drop
A down payment protects the bank, not the home buyer. Home values are tied to the U.S. economy. Usually, the economy is making incremental gains, and home prices rise.
But sometimes, the economy falters. This usually happens after extended periods of too hot growth. That happened in the late 2000s.
In this situation, consider two home buyers:
- Firstly, Buyer A: Puts 20 percent down on a $300,000 home.
- Secondly, Buyer B: Uses FHA home loans to put 3.5% down on a $300,000 home.
Concerning, Buyer A, he thinks he is being conservative by putting $60,000 down on a home. Buyer B puts down just $10,500. If these home values fall 20% neither Buyer A nor Buyer B will have any equity in their homes.
However, Buyer A will have lost a much bigger amount. Buyer B on the other hand, carries less risk of being foreclosed on if she can no longer make her payments. This is because banks know they will take a bigger loss repossessing a home with a larger outstanding loan balance. So, really, which home buyer is more conservative? The one who puts the least amount down.
3. A Down Payment Will Lower Your Rate Of Return
The first reason why conservative investors should monitor their down payment size is that the down payment will limit your home’s return on investment. Consider a home which appreciates at the national average of near five percent. Today, your home is worth $400,000. In a year, it is worth $420,000.
Irrespective of your down payment, the home is worth $20,000 dollars or more. That down payment affected your rate of return.
- With 20% down on the home, $80,000, your rate of return is 25%
- With 3% down on the home, $12,000, your rate of return is 167%
That is a huge difference. However, we must also consider the higher mortgage rate plus mandatory private mortgage insurance which accompanies a conventional 97% LTV loan like this. Low down payment loans can cost more each month.
Assuming a 175 basis point (1.75%) bump from rate and PMI combined, and then ignoring the homeowner’s tax-deductibility. We find that a low down payment homeowner pays an extra $6,780 per year to live in its home. With three percent down, and making adjustment for rate and PMI, the rate of return on a low down payment loan is still 106%, much higher than if you made a large down payment. The less you put down, then, the larger your potential return on investment.
Use A HELOC To Increase Liquidity
If you have already made a huge down payment, you can still deduct your risk with a home equity line of credit. Do it while the economy is doing well, lenders are offering HELOCs, and you have a job. If several of these factors disappear, then your access to your home’s equity will be extremely limited.
You can open a zero balance line of credit. You pay nothing in interest until the moment you draw funds from it. It is just like a credit card, with much lower rates of interest.
For one thing, you can open a (HELOC) with a $100,000 limit where you draw nothing. Especially, in an emergency, you draw $5,000 per month or as needed, until you are back on your feet. It is a convenient, low cost way of turning your home’s equity into potential cash.
Besides if your home value drops or if you lose your job, you can still take some cash out. With the terms of the (HELOC), they do not change based on home value or employment status. A zero balance (HELOC) is possibly the easiest way to form a financial cushion quickly if you have tapped most of your liquid assets into making a large down payment.