January 10, 2000, Revised August 29, 2007, Revised April 1, 2022
"I have enough cash to increase my down payment from 5% to 10%, or to pay up to 5 points, but not both… Which is better?"
There are two ways to answer this question. One way is to view the two uses of the available cash as investments, calculating the rate of return in each potential use. This is the approach used in the earlier version of this article. The second and current approach, is to compare total costs over periods that reflect borrowers’ expectations regarding how long they might remain in their house.
PART 1: RATE OF RETURN APPROACH
Paying Points and Increasing the Down Payment Are Investments
You can reduce or eliminate private mortgage insurance (PMI) if you increase the down payment, and you can reduce the interest rate by paying points. Both can be viewed as investments on which you make an upfront cash outlay and receives a stream of income in the future. With a larger down payment, the income is the reduction in monthly payment that results from the smaller loan and mortgage insurance premium. With points, the income is the reduction in monthly payment that results from the lower interest rate.As with any investment, you can estimate a rate of return. The better deal is the investment that yields the higher return over the period you stay in the home.
Factors Affecting the Return on Investment
The return on investment in points is extremely sensitive to how long you stay in the home. For example, suppose you are in the 28 percent tax bracket and pay 4.5 points to reduce the rate on a 30-year fixed-rate mortgage from 8 percent to 7 percent. If you stay in your house for 3 years, your after-tax return is a negative 17.8%. If you stay for 15 years your return is positive 15.9%.The return on an investment in a larger down payment is much less sensitive to how long you remain in your house. For example, to reduce the mortgage insurance premium on the same mortgage from .78% to .52% of the loan amount, you increase your down payment from 5% of property value to 10%. The after-tax return over 3 years is 11.3% and over 15 years it is 10.9%.
Finding the Answer in an Individual Case
The moral is very clear. If your time horizon is short, you should invest in a larger down payment, and if it is long, you should invest in higher points.How long is "long"? In most cases the crossover point where the returns are the same occurs in 8 years or less. However, the cross over point is affected by a number of factors including your tax bracket; PMI premiums; the rate reduction you receive for a given increase in points; and appreciation of your house, which affects how long you'll carry PMI.
You can analyze your own situation with three calculators:
12a.
Rate of Return From Investing in a Larger Down Payment
11c.Rate of Return From Investing in Points on Fixed-Rate Mortgages
11d.Rate of Return From Investing in Points on Adjustable-Rate Mortgages
PART 2: COST COMPARISON APPROACH
This approach is simpler than the rate of return approach in requiring only one calculator. See https://www.mtgprofessor.com/ext/partners/ShopYourLoan.aspx
The table below is drawn from that calculator. It shows clearly that over 3 years, costs are reduced more by making a larger down payment but over 12 years costs are reduced more by paying points. The table covers a 30-year fixed rate mortgage.
Paying Points Versus Larger Down Payment: Impact of a Cash Infusion of $25,000 Used to Increase the Down Payment on a $500,000 House or Reduce the Interest Rate by Paying Points
Use of Cash Infusion | Loan Amount | Ratio of Loan to Value | Interest Rate | Points | Total Costs Over 12 Years | Total Costs Over 3 Years |
None | $475,000 | 95% | 4.625% | $375 | $207,170 | $54,818 |
Larger Down Payment | $450,000 | 90% | 4.625% | $356 | $189,240 | $50,568 |
Payment of Points | $475,000 | 95% | 3.25 0% | $26,078 | $171,090 | $62,032 |
Note: Total costs include points, mortgage payments, mortgage insurance (if any), less reduction in loan balance, over 3-12 years. The home is a single-family primary residence to be purchased by a borrower with a FICO score of 800. Prices are as of April 1, 2022.
FAQs
If your time horizon is short, you should invest in a larger down payment, and if it is long, you should invest in higher points. How long is "long"? In most cases the crossover point where the returns are the same occurs in 8 years or less.
Is it better to put a large down payment on a house or invest? ›
The larger the amount, the better your interest rate will be. This can be especially helpful if you're trying to get a mortgage when mortgage rates are rising while home prices are falling. Putting less down and investing the difference is a riskier proposition in a rising-rate environment.
Does it make sense to make a larger down payment? ›
There are, in fact, many benefits to making a larger-than usual down payment, as we'll discuss below, including: avoiding having to pay for private mortgage insurance. reducing the amount of your monthly mortgage obligation. reducing the total amount of interest you'll owe.
Is it a good idea to buy points on a mortgage? ›
Mortgage discount points are portions of a borrower's mortgage interest that they elect to pay upfront. By paying points upfront, borrowers are able to lower their interest rate for the term of their loan. If you plan to stay in your home for at least 10 to 15 years, then buying mortgage points may be worthwhile.
Is it better to have a big down payment or big first payment? ›
Advantages Of A Large Down Payment
Not only will you reduce the size of your loan and lower those monthly payments, but you'll also have financial flexibility in future years. Bottom line: making a large down payment can help put cash back in YOUR pocket and reduce money stress and financial pressure!
Is it better to buy points or put more down payment? ›
The moral is very clear. If your time horizon is short, you should invest in a larger down payment, and if it is long, you should invest in higher points.
What are the disadvantages of a large down payment? ›
Drawbacks of a Large Down Payment
- You will lose liquidity in your finances. ...
- The money cannot be invested elsewhere. ...
- It is inconvenient if you will not be in the house for long. ...
- If the home loses value, so does your investment. ...
- You might not have the money to begin with.
If you use an interest-bearing loan, you could spend more paying it off than you would have if you didn't use down payment assistance. You could overextend yourself. Down payment assistance may allow you to purchase a more expensive home, but it could add financial stress down the road. Closing could take longer.
Should you ever pay more than 20% down? ›
If you do choose to invest more than 20 percent in your down payment, it's possible that you will gain access to a lower interest rate for your mortgage. Many lenders look favorably on homebuyers that are investing more of their own money and borrowing less.
Is it smart to put 50 down on a house? ›
It's not always better to make a large down payment on a house. When it comes to making a down payment, the choice should depend on your own financial goals. It's better to put 20 percent down if you want the lowest possible interest rate and monthly payment.
Cons of mortgage points
Upfront cost: You'll have to pay for points upfront at closing. This increases the initial cost of your mortgage.
How much is 2 points on a mortgage? ›
Each mortgage point costs 1% of your mortgage amount and will lower your interest rate by approximately 0.25%. For example, if your lender quotes you an interest rate of 6.5% on your $200,000 mortgage, you'll likely have the option to buy points to lower that rate. If you buy two points for $4,000, you'll shave .
Do lenders want you to pay points? ›
Mortgage points, also known as discount points, are fees you pay a lender to reduce the interest rate on a mortgage. Paying for discount points is often called “buying down the rate” and is optional for the borrower.
Why do sellers like big down payments? ›
Sellers may choose buyers with a larger down payment because of the higher chance that their financing will be approved. A lender may also see a buyer who puts down less money as riskier than one who can put down a larger amount because they are borrowing more money and have less investment in the property.
Is it better to have a large down payment or no debt? ›
THE SHORTER YOUR LOAN TERM, THE BETTER
A larger down payment can score you a shorter loan term, reducing the amount of time you have to pay off the loan. Yes, this means you'll pay more cash up front so you can save in the long run.
What is the best down payment size? ›
Home sellers often prefer to work with buyers who make at least a 20% down payment. A bigger down payment is a strong signal that your finances are in order, so you may have an easier time getting a mortgage. This can give you an edge over other buyers, especially when the home is in a hot market.
Is it better to invest money or pay down mortgage? ›
It's typically smarter to pay down your mortgage as much as possible at the very beginning of the loan to avoid ultimately paying more in interest. If you're in or near the later years of your mortgage, it may be more valuable to put your money into retirement accounts or other investments.
Why you shouldn't put more than 20% down on a house? ›
Downsides of a 20% Down Payment
Also, keep in mind that you'll need to have enough cash for closing costs and other savings needs. Won't provide as much benefit when rates are low: If mortgage rates are low, you could potentially put that money to better use by investing it or paying down high-interest debt.
Is it smart to put a lot of money down on a house? ›
A higher down payment means lower monthly costs
That said, there are benefits to making a higher down payment. Namely, when you put more money down up front, you'll pay less per month and less interest overall.
Is it better to pay off primary residence or investment property? ›
Choosing between either paying off a primary home or rental property will depend on which you value most. Paying off your rental can increase your cash flow and equity, but paying off your primary residence secures a roof on your head. Another key factor to consider is the respective interest rates.
