What is the optimal down payment? Hint: It's less than you think

[Jay Voorhees]

All too many homebuyers mistakenly believe that they need to put down as much as humanly possible for several reasons: (1) they want to minimize their housing payment; (2) they want to minimize their debt load; and (3) they want to make their offers appear stronger.

However, I often advise buyers to put down LESS depending on their financial profile for these reasons: 

1. "Cash to Close" is much greater than buyers expect

“Cash to close” includes the entire down payment, all closing costs, transfer taxes, and prepaid interest, property taxes, and insurance.

And the final number is almost always larger than most buyers expect. “Cash to close” is never just the down payment amount like many buyers mistakenly believe.

If buyers are buying in an area with high transfer taxes and if they are setting up an impound or escrow account, “cash to close” can exceed the down payment amount by as much as $25,000 for purchases as small as $500,000.

Buyers often need to put less down in order to preserve enough extra cash to cover “cash to close.”

2. You'll likely need Reserves

"Reserves" are the funds remaining in a buyer's accounts after a transaction closes. While required reserves are negligible for most Fannie Mae and FHA loans, they can be substantial for jumbo loans, e.g. 12-month PITI, investment property loans, and for buyers with multiple properties.

BUT, reserves are not just necessary to meet lending requirements. New homeowners often need ample reserves for repairs, improvements, furniture, appliances, window coverings, and many other unexpected expenses.

For example, I still remember the angst of some first-time homebuyers who bought a very cute 80-year-old bungalow, and who also had to scrape up $4,000 for some urgent plumbing repairs that surfaced soon after they moved in.

3. Mortgage debt over consumer debt

Because mortgage debt is spread out over 30 years, because the interest is tax-deductible in most cases, and because mortgage interest rates are so low, I almost always advise buyers to put less down if they have high consumer debt balances, e.g. credit cards, auto loans, etc.

You can easily save hundreds of dollars per month by swapping high rate, short-term consumer debt with lower rate, long-term mortgage debt.

4. Putting down less money only marginally impacts payment

In this rate environment, putting down $25,000 less will only increase one’s mortgage payment by $105 (assuming a 3% rate).

Every $10,000 added to a loan amount at 3% only increases the total payment by $42.

5. Making offers seem stronger

One of the biggest reasons homebuyers want to put as much money down as possible is to make their offer seem stronger. I have seen my wife and business partner, Heejin, talk listing agents into accepting offers with FHA financing and 3.5% down over other offers with as much as 30% down dozens of times. She does this by touting the strength of the buyer's pre-approval, the lender's appraisal speed, and the fast close time.

In other words, a strong lender-reputation and a full pre-approval in combination with fast turn-times and a phone call to the listing agent often make a large down payment irrelevant.

How much do you think buyers need to put down to win offers today?