What is the optimal size for a down payment?

Posted by  on Nov 22, 2012

Q: I've been saving up a down payment for a home, and I'm making good progress. I'm getting close to 20 percent, at which point I could pull the trigger, but I've gotten kind of fascinated by playing with an amortization calculator, and specifically looking at how much interest I'll save with a bigger down payment. For example, at 3.5 percent, it looks like I'd save about $6,165 in interest for every additional $10,000 in my down payment. So, my question is, Is there an optimal-sized down payment, or should I just keep saving until I simply can't hold off on moving into a house any longer?

A: A big down payment is healthy because it gives you instant equity in the home and makes your monthly payments more affordable -- two things which reduce your risk of foreclosure in the event of some future setback. Beyond that, though, there isn't any magic inflection point which represents the perfect down payment. At a given interest rate, each dollar you knock off the loan will save the same amount of interest. So in mathematical terms, the benefit of a higher down payment is measured in a straight line rather than by any kind of a curve.

However, there are two additional things your mortgage calculator won't measure:

  1. Your rent: Remember, while you are saving for your down payment, you are also paying rent. So, in calculating the net savings from waiting to build a bigger down payment, you have to subtract the rent you'd pay in the meantime.

  2. Interest rate risk: 30-year mortgage rates hit a new low in mid-November, at 3.34 percent. Interest rates can be extremely volatile, so the longer you wait, the more you risk missing out on historically low rates.

All things considered, once you cross the 20 percent threshold, it would be a good idea to be ready to pull the trigger, as long as the property is right and the payments are affordable.

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