One important question that you’ll likely ask yourself when searching for a piece of property is, “how much should I put down on a house?” The answer to this question isn’t exactly black and white, and really depends on your personal situation and school of thought.
First and foremost, you need to decide what amount of money you’re comfortable investing in your illiquid asset of a home. For some this may be a difficult decision, but for others it may be a choice made out of necessity. Either way, make sure you give it a lot of thought before writing that check.
Small Down Payment = Large Mortgage Payment
If you choose to make a small down payment, you’ll end up paying a lot more each month to make up the difference. And over the life of the loan, you will pay a lot more in interest assuming you hold onto your loan for a decent amount of time. Conversely, if you put down too much you may find yourself stretched too thin, living paycheck to paycheck to cover the cost of your mortgage each month.
That said, remember that the less you put down on your home, the more difficult financing the property becomes. In fact, these days many banks and lenders have done away with 100% financing because it has become too risky.
Additionally, it’s more difficult (and expensive) to get your hands on a jumbo loan, so keeping your loan in the conforming zone could also sway your decision. Either way, if you put more money down, you’ll enjoy a lower interest rate and a broader array of financing options. Just make sure you have enough money to make your monthly mortgage payments after the close of escrow.
Piggyback Mortgage or PMI
If you do decide to come in with less than 20% down, you’ll have to decide between a second mortgage or private mortgage insurance (PMI). If you choose to stick with one loan, you’ll need to pay a little bit extra each month to cover the mortgage insurance premium (this is on top of homeowners insurance). But keep in mind that it recently became tax-deductible.
If you’d rather avoid the PMI, you can add a piggyback mortgage behind your first mortgage. Though rates are typically higher on a second mortgage, the loan amount will likely be small, making the interest rate and monthly payment less substantial. Use a blended rate mortgage calculator to decide if it’s cheaper to hold two mortgages as opposed to paying PMI.
Tip: Recently some banks have launched loan programs where mortgage insurance is lender-paid, so make sure you’re aware of all your options.
Seasoned Funds are the Best Funds
Regardless of how much you decide to put down on your home, make sure the funds you come up with are seasoned. Seasoned funds are typically assets that have been in a verifiable account for at least two months. That means a checking or savings account, or 401k or stock portfolio, to name but a few. Gift funds and “mattress money” will be problematic with the bank or lender, so make sure you set aside enough funds at least 60 days before you set out to purchase a home in your own, personal account. It’ll save you a lot of heartache down the line.
Aside from down payment funds, you’ll also need to come up with asset reserves to cover a specified amount of monthly mortgage payments. This requirement can vary by lender, but will typically be at least two months of principal, interest, taxes, and insurance (PITI). So don’t blow all your money on the down payment, or you could blow the whole deal. And don’t forget about closing costs, which will likely be 2-5% of the purchase price.
Finally, decide on a down payment that works for you. We’re all unique and have diverse financial agendas and comfort levels. If you believe you can invest at a higher rate than your mortgage interest rate, a zero down payment may be best for you. But if you’re the type who plans on staying put and paying down your mortgage to zero, putting more money down upfront would likely be a good idea.
Read more: How to buy real estate with no money down.