Down Payment Options: What's My Best Bet?

Source: Informa Research Services

Everyone knows that the standard is to put 20% down on home purchases. But is this my best bet? In making this choice, do the math and ask yourself the following 3 questions:

1. How long do I plan on living in the home?
Depending on how long you intend on living in the house, you may or may not choose to make a substantial down payment. If you plan on staying in the home for a longer period of time, you may want to look into making a larger down payment if possible. However, because you don't get your down payment back, you may want to think about putting less money down if your plans are still up in the air.

Also, figuring out whether you plan on staying in your home for 3 years or 30 years will help you decide what kind of loan you should get. For instance, if you plan on staying in your home for a shorter period of time, you may consider looking for an adjustable rate or interest only mortgage loan.

2. How much can I afford to spend on my monthly mortgage payments?
Because your down payment affects the amount you are borrowing, it affects the size of your monthly payments as well. Typically, when a larger down payment is made (and as a result, a smaller amount is borrowed), monthly payments are smaller. However, if this is not one of your options, then be sure that your monthly payments fit into your budget. Think about what kind of loans are available because your monthly payment will be determined by the type of loan you have. For instance, if you choose a 30-year fixed mortgage over an adjustable rate mortgage (ARM), your payments will stay the same for the life of the loan where as the payments on an ARM may change after the initial term of the loan.

Remember, if you do not put 20% down, you may need to pay private mortgage insurance (PMI), which will be added to your monthly payment. Unlike the interest paid on most mortgages, PMI is not tax-deductible. The alternative to paying PMI is to get a "piggy back" loan, or taking out a second loan to help finance the 20% down payment.

3. What options does my credit score provide me?
It is important to see what options are available to you depending on your credit score. Good credit can save you money by qualifying you for better interest rates on your mortgage loan. For instance, let's take a person with a credit score under 620 versus a person with a credit score of 720 or higher (assuming a standard 30-year fixed, $300,000 mortgage loan). The person with the lower credit score would qualify for an annual percentage rate (APR) of 9.715% while the person with a higher credit score would qualify for an APR of 6.080%. In this example, having a better credit score could save you approximately $756 a month, or $9,072 a year (Source: MyFico.com).

Credit Score APR Monthly Payment
Less than 620 9.715% $2,570
700 and higher 6.080% $1,814
Total Savings 3.635% $756/month
(or $9,072/year)

This applies not only to first mortgages, but second ones as well. For those with impressive credit, getting a "piggy back" loan can be less costly than paying private mortgage insurance. The rates available depend on your credit score, so be sure to use available resources to research rates.