Why A Large Down Payment Isn’t Always Best, Take Two.

by Joseph · 1 comment

in Loans and Credit

Yesterday I posted a blog entry about down payments when purchasing a home and why I found that paying extra down doesn’t necessarily save you much money over the life of the loan. Turns out that my findings were highly controversial. Before you do anything else make sure to read Does A Large Down Payment Save Money In The Long Run, and DO NOT forget to read the comments as well.

The whole point that I was trying to make is that it’s good to think outside of the box sometimes. Why use all of your cash for a larger down payment when you don’t have to, right? Also there are ways to save money on a mortgage by not paying extra down on the purchase of a home.

Controversy on Debit versus Credit

However like I mentioned earlier my previous post about paying less toward a down payment is the most controversial post that I’ve ever written, as evidenced by all of the negative comments toward it. I even had someone e-mail me demanding that I take the post down because it is misleading, especially when I claim to be fighting financial ignorance here at Debit versus Credit.

The funny thing is that they’re all right.

I’ll admit when I’m wrong. That post was slightly misleading, but I can assure you that those were not my intentions. I will not back that post off, however, because I still stand behind the point that I made in it. Let me explain.

Here’s the thing: when you take out a 30 year mortgage the mortgage firm will amortize the entire amount you borrow into a 30 year payment plan. So when you borrow less (because you paid more down) then your monthly payments are going to be lower. The amortization schedule above reflects that. This is where the majority of the complaints about my previous post came from. They said I wasn’t comparing apples to apples.

Why I Won’t Back Down

Maybe I wasn’t being fair in my comparison, but the way I look at it the average consumer is not going to care about anything other than their monthly payment and how much cash they are spending out of their own pockets. If they see a monthly payment that is only $7 a month less after paying an extra $7,500 cash out of their own pockets toward a larger down payment they are not very likely to want to pay that extra $7,500 cash.

In fact my guess is that they’d be more likely to prefer a lower down payment with the option of paying more to lower their interest costs and the time spent paying down their loan. The world of finance is all psychological and I fall into this category as well. I’d rather pay less of a down payment, keeping the cash for emergencies and applying it over time as extra principal payments. Obviously it’s not a completely fair comparison, but it makes sense why there might be some advantages to doing it this way.

Their Comments Did Make Sense, Mathematically

With that being said I’d like to point out that the previous commenters were right. If you paid the 10% down AND paid the same amount towards the loan as you would with the 5% down payment you would save a LOT more money. In fact you’d save about $30k over the life of the loan, as well as have it paid off 40 months earlier. That’s an awesome difference and something that is worth considering.

There Are Still Reasons To Pay Less Down

However if you have the cash to pay extra down but are worried about using all of your cash then don’t use it all. You can still save money. Just plop that cash in a high interest-bearing savings or money market account and pull a little bit out of it each month to through towards your mortgage payment. You’ll save money over the long run and you’ll still enjoy the peace of mind that comes from having a substantial cash pile.

{ 1 comment… read it below or add one }

Bret Frohlich January 31, 2009 at 12:28 am

The spreadsheet and analysis are interesting.

But, you will likely get a better interest rate and avoid PMI (Private Mortgage Insurance) by coming up with a larger down-payment. PMI is a 100% waste of your money.

Then, if you really want to save, you could pay a little extra on your monthly payments. This would be about the same monthly payment as with a smaller down payment.

You could cut years off of the mortgage and save thousands of dollars, all with the same monthly payment.

Bret Frohlichs last blog post..Why I Never Budget

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