Should I save on interest with a bigger down payment?

Q: My wife and I are looking to buy a $300,000 house and have saved up $100,000. We'd need $60,000 for a 20 percent down payment, but savings account rates are so low that I'm thinking of putting all $100,000 into the down payment so I can save money on interest with a smaller mortgage. What do you think?

A: At just under 4.5 percent, today's mortgage rates seem fairly low, but you make a good point about savings account rates. According to the FDIC, as of early March the average savings account rate was just 0.06 percent. As low as mortgage rates are, the spread between mortgage rates and savings account rates is unusually wide. That means you have more to gain than to lose by putting money into the house rather than into a savings account.

However, there are two questions you should ask yourself before you put all $100,000 into your down payment:

  1. Do you have an emergency fund set aside? Before you clean out the savings account completely, you may want to make sure you keep some kind of reserve for emergencies, whether it is an unexpected expense or an employment setback. The last thing you want is to get caught short just when you have taken on a mortgage payment.
  2. What long-term savings do you have? Unless you and your wife have already started saving for retirement, you might want to consider putting some of your savings into long-term retirement investments.

A compromise strategy might be to make a 20 percent down payment but take on a shorter mortgage. You could then use some of the excess savings to meet the higher monthly mortgage payments that come with a shorter mortgage. You would save on interest both by shortening the payback period of the loan and because 15-year mortgage rates are running nearly a full percentage point below 30-year rates. In the meantime, though, you would keep some of your cash reserve available for unexpected needs.

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