Benefits of a Larger Home Loan Down Payment

When contemplating the purchase of real estate and taking on the responsibility of a home mortgage loan payment, borrowers often ask themselves a question that many don't quite understand: how much of a down payment should I make?

A down payment is the lump sum of money a borrower puts towards the purchase of a home loan upfront. Regardless of whether a borrower puts down 5 percent or 50 percent, the down payment goes towards the principal of the loan. As a result, money spent on the down payment is never wasted. Rather, any money withheld from the down payment would eventually be repaid through the course of normal monthly payments.

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The amount one should put towards their down payment directly correlates to money saved in the long run. The benefits of a larger down payment affect the amount of money saved through three significant means: smaller monthly payments, lower interest rates, and the avoidance of private mortgage insurance (PMI).

Reduce Mortgage Loan Payments

By securing a property with a larger down payment borrowers can enjoy reduced mortgage loan payments over the entire duration of their home loan financing. Whenever principal is reduced, but the term is kept the same, borrowers can expect to see reduced monthly payments. Lower payments mean a smaller portion of a borrower's money is going towards interest, and less money going towards interest means more long-term savings.

Consider a borrower with a mortgage loan of $300,000 at 5 percent interest over a 30 year term. Without factoring in taxes and insurance, if our borrower put down just 10 percent, or $30,000, on this home loan, he could expect to pay approximately $1,449 every month. After a full 30 years, that borrower will pay back the full $300,000 plus $251,790 in interest.

Now imagine that same borrower agreeing to a full 20 percent down payment, or $60,000. That would reduce his monthly payments to approximately $1,288 and it would reduce his total interest payments to $223,813 over 30 years. That's a savings of almost $200 a month, and nearly $20,000 over the life of the loan.

Lower Interest Rates

Interest rates are largely affected by a borrower's initial loan-to-value (LTV) ratio. The LTV ratio is calculated by taking the amount remaining on a mortgage loan divided by the appraised amount of the property it is securing. For instance, if our aforementioned borrower secured a property worth $300,000 and put 10 percent down, resulting in a mortgage loan of $270,000, he would have an LTV ratio of 90 percent.

When a lender is trying to determine an interest rate for a borrower, the lender will look at what the borrower's initial LTV ratio will be. The larger the down payment a borrower is willing to make, the lower the LTV ratio. The lower the LTV ratio, the better the lender's interest rate offer will be.

If our borrower put down 20 percent, resulting in a mortgage loan of $240,000, his LTV ratio would be 80 percent, thus prompting the lender to give him a better interest rate.

Borrowers, particularly those who plan on occupying their property for an extended period of time, would be wise to secure the lowest interest possible, since interest is essentially the price it costs to borrow money.

Private Mortgage Insurance

Finally there's the issue of PMI. PMI is a security measure required by lenders for any borrower who does not have at least 20 percent vested in their home. It is largely due to this requirement that many experts advise all borrowers put at least 20 percent down on the purchase of any home.

PMI is paid annually, and usually costs between 0.5 and 1 percent of a property's appraised value.

If our borrower didn't put down a full 20 percent on his $300,000 property, he can expect to pay anywhere from $1,500 to $3,000 for PMI every single year.

By taking monthly payments, interest rates, and wasted money on PMI, it's easy to see the benefits of a larger home loan down payment.

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