Guest Author - Rhonda Cliett
The down payment is the portion of cash that a buyer pays up front prior to the purchase of a home. While it is possible to purchase a home without a down payment, you must decide whether or not this is the best choice for your situation. Generally, the larger the down payment, the better rates and terms you will receive from the lender.
By making a down payment of at least 20%, you will not be required to purchase Private Mortgage Insurance (PMI). PMI is designed to protect the lender from potential losses should you default on your loan. If you do not have at least 80% equity in your home (this is achieved by paying at least 20% down payment) you must purchase PMI. The cost of PMI is included in your monthly mortgage payment.
Another consideration is the tax impact of a larger down payment. Let’s say that you take money from your savings account and use it as the down payment on your home. What are the pros and cons of this situation?
PROS
• You will not have to pay tax on the interest earned from your savings.
• You will most likely receive better rates and terms from the lender.
• Making a larger down payment will reduce the amount you have to borrow, as a result, you will pay less interest on the total life of your mortgage.
CONS
• You will no longer receive the interest earned from having your money in savings. However, if you receive a fixed rate mortgage of 5% (for example), you will need an average annual rate of return on your savings of 5% in order to come out ahead.
The source of your down payment will determine the total tax consequences. If you are lucky enough to have relatives who will give you the money for a down payment, then you will definitely come out ahead. If you have a retirement plan, you might be able to withdraw money and use it as a down payment without suffering penalties. You must weigh the benefits of the reduced balance in your retirement plan versus the benefit to your overall mortgage situation. This could be done much in the same way as we weighed the “pros and cons” above.
If you are fortunate to have the resources available to make a significant down payment on your home then you must weight the pros and cons of your decision. The majority of individuals are going to find it more economically smart to make a down payment. Weigh the pros and cons against your individual situation and you will be able to make a wise decision.
Qualifying for a Mortgage Series
Qualifying for a Mortgage - The Basics
Buying a Home Without a Down Payment
The Facts Regarding a Down Payment
Understanding Your Credit Report
Understanding Your Credit Score
Loan Prequalification and Preapproval
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