This subject as it relates to real estate loans will be, in many situations, a subjective call. I think, however, it is important to open it up to discussion. If you or a family member are in the process of buying a home, what is your thinking about the amount of money to put down? When your parents or grandparents were making the decision to purchase, the prevailing requirement for a downpayment was 20% or more. A lot has changed in the ensuing years! Today you can buy a home with no money down, have the seller pay up to 6% of the purchase price for closing costs and probably walk away with money in your pocket at the completion of the transaction. A good deal . . . it doesn't happen every day.
Should you put a limited amount of money down or should you dig deep to come up with a 20% downpayment? Can one save 20% today, if that were the requirement? For many, the answer is no. However if you do have 20% available for a downpayment, should you use it? When you put 20% down on a new home purchase, the money is now sitting in the home. It is not liquid (cannot be accessed quickly). If you need it, you must now borrow your own money. If there is a reduction in value as we have seen in the decade of the nineties, the equity in the home may not be sufficient to get a home equity loan or equity line of credit. If you opt for one of the high loan to value loans currently in vogue, you will be paying interest of 12«% or higher. So, if you have a question about which way to proceed as to how much downpayment to commit to the purchase, you should put the figures on paper. Putting figures on paper however, may not be the entire solution. You must also feel comfortable with your decision as to monthly payment and your overall financial goals.
For example, let's look at a 20% downpayment applied to a home purchase of $250,000. The loan will be $200,000. Let's compare this scenario with a 10% downpayment and a loan of $225,000. We are keeping in our savings account the $25,000 that could have gone to the downpayment. We will also assume a 6% simple interest rate. All things being equal, let's put on paper the above hypothetical. Payment for 200,000 loan @ 7«% for 30 years is 1,399 (rounded off). Payment for 225,000 loan @ 7«% for 30 years is 1,573. Obtaining a loan for 225,000 will let you put 25,000 in your savings account. Six percent simple interest on the $25,000 will give you a return of $1,500 per year.
If you can afford the $1,573 per month (from above), you can now add an extra $125.00 per month, i.e., your monthly interest (1,500 divided by 12) to your monthly mortgage payment. Your total mortgage payment is now $1,698 per month. What will this accomplish? First, your mortgage is paid off in 23 years and 7 months. Second, you still have the $25,000 you started with in your savings account. After your loan is paid and assuming 8% return on the $25,000 for the 6 years 5 months you cut off your loan the total will amount to over $41,900. Third, you can take the $1,573 per month that would have gone to loan payments and invest that sum for the 6 years and 5 months that were cut from your 30-year loan. If you did this with an assumed 8% interest rate, the accumulated sum will amount to over $144,700. As you can see, a lower downpayment may allow you to repay your loan and in this situation accumulate over $186,000 during the time that you would ordinarily be paying on a 30-year loan. As you can see, less may be more.