Questions and concerns over how much to put down on a home purchase come up time and again with every client I meet with. Some people come in already knowing they want to put absolutely nothing down, others want the minimum statutory investment, and others want to sink every penny they have saved into their home purchase. Which method is the best?
Liquidity is how easily accessible that particular investment is if you need it. A down payment is instant equity in a home but there are only two ways to get that money back. You can borrow against your home in the version of a new mortgage or home equity line or you can sell your home to access the proceeds. In both cases there are costs involved to access those funds again and in most cases may even exceed the down payment. Rate of return is how much your investment will earn for you. In the case of home equity the answer is zero. Your house goes up or down in value based comparable market sales and has nothing to do with your down payment. Safety of principal refers to the likelihood that you will lose that investment. In years past you could rest assured that the value of your house would increase steadily through the years. However, in the past few years we have seen significant declines. Under this example, if you put a 5% down payment ($10,000 on a 200,000 purchase) into your purchase and the housing market in your area declined 5%, where did your down payment go? The house you bought for $200,000 is now worth $190,000, the same as your initial mortgage balance. Your investment is completely gone until the market rebounds. Does putting money down past the three way test for prudent investments?
Now the client says, “But won’t my payment be a lot higher?” Let’s compare two options related to a $200,000 purchase. If you buy with a Conventional mortgage at 4% you would have a principal and interest payment of $907.09. Estimated private mortgage insurance (PMI), assuming a good credit score, would be around $79 a month. Total mortgage payment excluding tax and insurance escrows is $986.09. If we bought through a no money down option at 4%, principal and interest would be $973.93 plus mortgage insurance at $51 a month. Total mortgage payment excluding tax and insurance escrows would be $1024.93. Of course having a smaller mortgage is going to make for a smaller payment. But is it worth it? In this scenario, putting $10,000 down lowered the monthly obligation by $38.84. If you physically saved the $38.84 every month you would not recover your initial investment of $10,000 for over 21 years. Would it have made more sense to keep your $10,000 in the bank where it was liquid, earning interest, and was not at risk of a housing market decline?
The bottom line to all of this is that not every financial concept applies to every client’s needs. My focus is always to help you evaluate where you are and where you want to be and help you make the most prudent decisions for you and your family.