A higher down payment doesn’t always mean a better down payment.

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When you’re extending an offer to buy a home, how do you know what the optimal down payment should be? There are four main factors to consider to find that answer:

 

The first is your monthly housing expense. Lenders will calculate your debt-to-income ratio, which is a pre-tax calculation that uses your gross income. You want to calculate how much of a monthly mortgage payment you’re comfortable managing each month. This isn’t just a mortgage payment; it also includes your property tax and insurance payment. Your property tax is usually about 1.25% of your purchase price, and the average insurance payment is about $80 per month. If you’re buying a condo or townhouse, don’t forget to add the HOA fee.

 

Adding these numbers up and dividing that total by your monthly income is how a lender calculates your debt-to-income ratio. If this ratio is too high (usually, they prefer it to be less than 43%), you won’t be able to get that much of a loan anyway. 

 

“If some of your funds can be put to better use elsewhere, then I don’t recommend putting all of your eggs in one basket."

 

The second factor is your cash flow. A lender will advise you on what monthly payments you can manage based on their professional perspective, but after putting aside your 401(k) and paying other expenses, how much cash is left? Compare that remaining amount with your housing payment to see whether you’re comfortable with it. 

 

Next, consider the funds you’re willing to put toward your down payment. If you have lots of funds to work with, does it make sense to put all of them toward your down payment or withhold some for a rainy day? Perhaps you have other potential investments that offer a better return? Right now, interest rates are very low (3% or lower), so every additional $100,000 in mortgage costs equates to about $420 more per month. If some of your funds can be put to better use elsewhere, then I don’t recommend putting all of your eggs in one basket, so to speak. 

 

The last factor to consider is whether you’ll be facing competition when making your offer. The higher the down payment you can make, the more comfortable the seller will feel. 

 

As always, if you have questions about this or any real estate topic or are thinking of buying or selling a home soon, don’t hesitate to reach out to me. I’m happy to help.