If you could pay for a home with cash without getting mortgage financing, would you? Should you? That decision is both an emotional one and a financial one. Let’s look at a recent example…
We received a call from a potential customer, referred to us by a real estate agent we work with, who was looking to get qualified for a home price of about $400,000. He had just received a large inheritance and was debating on exactly how much to put down on the home. He had a figure in mind but wanted to run the numbers. Here is how the numbers played out at his figure of $250,000 down:
| Purchase Price | $400,000 |
| Down Payment | $250,000 |
| Loan Amount | $150,000 |
| Principal & Interest Payment @ 5% rate | $805.23, 30 year fixed |
Pretty good payment for a $400,000 house! Now that we know what it would look like based on the number in his mind, we started to play with the numbers a bit.
First let’s look at how much you can save for every $1,000 you put down. Through a simple mortgage calculator you can calculate how much $1,000 over a 30 year loan, fixed at 5% will change your monthly payment. It comes out to $5.37/mo. What this means is that for every $1,000 you put down your principal and interest payment will decrease about $5.37/mo. In this example, he is putting $250,000 down or $236,000 more than the minimum (minimum is 3.5% or $14,000). That means that the monthly principal and interest savings is about $1,267.32 (236 X $5.37). 5% is a great rate and historically very low, so let’s look at some other examples based on average 30 year fixed mortgage rates from Freddie Mac:
- 2009 Average= 5.04% or $5.39/mo per $1,000 down
- 2000 – 2009 Average = 6.29% or $6.18/mo per $1,000 down
- 1972 – 2009 Average = 9.28% or $8.25/mo per $1,000 down
When people see these figures they are normally very surprised how little $1,000 down will impact their payment. There are certainly other factors to consider though. Probably the biggest factor to consider is mortgage insurance. Mortgage insurance protects your lender and is required when you put less than 20% down on a mortgage. There are 2 main types of mortgage loans and the monthly mortgage insurance amounts vary for each:
- FHA – 1.75% Up-Front Mortgage Insurance Premium (Changing to 2.25% Apr 5)
- .55% of loan amount divided by 12
- Conventional
- 5.00 to 9.99% Down Payment = .94% of loan amount divided by 12
- 10.00 to 14.99% Down Payment = .62% of loan amount divided by 12
- 15.00 to 19.99% Down Payment = .38% of loan amount divided by 12
These mortgage insurance factors add a level of complexity to calculating the savings of putting more down. Let’s look at the monthly payment of principal, interest and mortgage insurance at different amounts down:
| $200,000 Purchase Price, 30 Year Fixed at 5% | |
|---|---|
| FHA, 3.5% Down | $1,142.66/mo |
| Conventional 5% Down | $1,168.79/mo |
| Conventional 10% Down | $1,059.28/mo |
| Conventional 15% Down | $966.43/mo |
| Conventional 20% Down | $858.91/mo – NO MI |
Based on this table you can see that by putting down an additional 5%, or $10,000, you save more than just the $5.37/mo, calculated in the first example. The difference between Conventional 5% and Conventional 10% is $109.51 instead of the $5.37/mo per $1,000 down calculation of $53.70. This is because of the drop in the MI factor dropping from .94% to .62%.
Getting back to our example with this gained knowledge we know that a 20% down payment should be the least amount the customer should consider. This will allow him to avoid paying mortgage insurance and provide him the biggest bang for his buck. From there it became a decision of personal choice and calculating whether to put money down or invest with a better return on his money.
Rather than redo all the calculations on this question, I will direct you to check out Get Rich Slowly who wrote a post titled Ask the Readers: Is it Better to Invest or Prepay a Mortgage. The great thing about this post is that it not only gives you great resources for making this decision but also gives you the calculations and opinion of others.
My customer decided that even though he may be able to get a better rate of return in the stock market or other investments he still wanted to put the full $250,000 down. Ultimately you are the one that needs to determine what is best. Mathematical calculations will likely show it is better to invest than to buy down the mortgage but the emotional side of having the security of a low monthly mortgage payment can weigh heavily on this decision.
Lending A Hand
Scott Wynn
The Wynn Team
Tags: down payment, Mortgage Insurance, Strategies
