Many homebuyers in the Beehive State are more motivated to save as much as money for down payment. After all, paying a large amount of cash toward the purchase quickly builds equity on the property. Payers of bigger down payments are more entitled to lower mortgage rates in Utah. In addition, putting down 20% of the sale price saves you the burden of your paying PMI, thus further reducing your monthly repayments.
Furthermore, the bigger your down payment, the smaller the amount you need to borrow you purchase a property. This means lower monthly obligations — and possibly more peace of mind.
But did you know that large down payments come with risks as well? If you’re a reasonable borrower, you’d probably shake your head in disbelief to learn that paying as much cash as possible to start your mortgage may even work against you down the road.
It’s terribly shocking at first, but here’s why it may put you at the disadvantage:
Limiting Your Returns
If you buy a $450,000 property and put down $90,000, or 20%, your returns wouldn’t be as much if it appreciates at 6% ($27,000) after a year as opposed to just putting $13,500, or 3%. Regardless of down payment’s size, the property would still worth $477,000 a year later.
Imagine: your rate of return could’ve been 200% if you only put down 3%. Instead, your rate of return is only 30% with your 20% down payment.
Turning Your Cash into an Illiquid Asset
Once you pay cash for your home purchase, it automatically transforms into a different type of asset, called home equity. Now, the only way to convert your home equity into cash is by selling the property or refinancing the mortgage. Either way, it would cost you money.
But if you keep 17% of your supposed 20% down payment, you could have more money in pocket available for spending in times of need.
Risking Foreclosure More
One of the biggest mortgage misconceptions is a large down payment can help avoid foreclosure. Well, this is only true as long as it keeps your loan from turning upside down. But avoiding an underwater status doesn’t keep you from facing eviction — your repayments do.
If you and another homeowner with an underwater mortgage both default on your monthly payments, expect the lender to kick you out first. This is because your property with presumably little equity is lesser of a loss to the financial institution.
Big and small down payments have pros and cons. It’s up to you to analyze the potential benefits and drawbacks of your down payment size to pay an amount that makes the most sense to you.