It is not always mandatory to produce a down payment when buying a home, but it can make it easier to secure financing. Putting in a greater amount on the down payment might even produce a more favorable mortgage.
The effects of a larger down payment are not always positive, but they can create important advantages for the buyer in some ways.
Reductions in mortgage payments
Paying more upfront reduces the amount a buyer needs to borrow. This leads to smaller monthly mortgage payments, freeing up more income for other expenses and savings goals. Lower payments also make it easier to qualify for the loan and reduce the risk of overextending finances.
Smaller interest rates
A larger down payment can also result in a lower interest rate. Since the buyer has more equity in the home, the buyer poses less risk to the lender. Interest rates on a conventional mortgage can reduce 0.25% or more when a buyer makes a down payment of 20% rather than a much smaller amount. This could save the buyer thousands of dollars over the course of the mortgage.
Elimination of private mortgage insurance
Paying 20% or more as a down payment also allows a buyer to avoid paying for private mortgage insurance. While PMI protects the lender if the buyer defaults, it offers no benefit to the buyer and can actually be a money drain. This additional recurring cost can equal 0.5%-1% of the total loan amount annually. On a $200,000 mortgage, paying PMI could cost an extra $1,000 or more per year.
Possible drawbacks of a larger payment
A primary issue with putting more money down is that it reduces access to funds. A buyer who needs more money for other expenses related to the property will not have as much on hand if it goes into a down payment.
Another negative is that it could push back the purchase of the property. The buyer might need to wait for a longer period of time to save up a larger down payment. Because the buyer needs more time before making an offer, the seller might decide to entertain bids from other buyers.
Producing a large down payment will generally depend on the finances of the buyer, as well as any priorities the buyer has for the property which may require a timely purchase.
