How Much to Put Toward Your Down Payment

One of the biggest barriers to homeownership is the size of the down payment required to qualify for a loan. Gone are the days when mortgage lenders routinely issued mortgage loans with 0% down payment requirements. In the wake of the housing crisis, mortgage lenders are much more likely to demand down payments closer to the standard 20%, even for borrowers with good credit. However, if you have excellent credit, you still have a good chance of qualifying for a home loan with a down payment of less than 20%. So if loan approval isn’t an issue, how much of a down payment should you make toward your next home? We’ll tell you the answer in what follows.

The Down Payment Gold Standard

The rule of thumb for down payments has always been 20%, and for good reason. A 20% down payment on a home helps you build equity more quickly, which reduces the possibility that you will end up owing more on your mortgage than your home is presently worth. Moreover, a 20% down payment means that you will not have to pay private mortgage insurance, or PMI, which protects the lender in the event you default on the home loan. Most importantly, making at least a 20% down payment will help you considerably reduce your monthly payments and interest expenses over the life of your mortgage.

Opportunity Cost

Let’s first assume that you have the cash requisite to make a 20% down payment on your home. So if you have the money, does that mean you should automatically make the largest down payment possible? The answer will depend on your other investment opportunities, or the opportunity cost of investing a significant amount of money on your mortgage. A larger down payment will yield a significant return over time, but it may not yield the returns you could achieve through other investments, such as stocks, bonds, etc. If you are certain that you could earn a higher return on your down payment money with another investment, then a smaller down payment makes more financial sense.

Credit Changes Everything

If you have credit challenges, you may not have much of a say in the size of your mortgage down payment. Your lender may require you to make a down payment of 20% or higher before you can qualify for a mortgage loan. For people with imperfect credit, a larger down payment will not only help your chances of getting approved, but it will also improve the interest rates for which you qualify. Lenders tend to charge borrowers with credit challenges significantly higher interest rates, but a substantial down payment can help mitigate the elevated rates.