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Down Payments and Points

Paying more money upfront will reduce your monthly payments as well as the total cost of your mortgage, but there are two distinct ways to go about this. Learn about the effects of down payments and discount points so you can strike the right balance between them.

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The Down Payment

A down payment is money you pay upfront so you don’t need to borrow as much. A higher down payment means a smaller loan, which means lower monthly payments and less interest to pay in the long run. Look at this example to see how the down payment affects your costs even when the term and interest rate stay the same:

Example – Price: $150,000 | Loan Term: 30 years | Interest Rate: 5% Down Payment: $15,000 → Loan Amount: $135,000 → Monthly Payment: $725 → Total Cost: $260,895 Down Payment: $30,000 → Loan Amount: $120,000 → Monthly Payment: $644 → Total Cost: $231,907

In this example, increasing the down payment by $15,000 lowered the total cost by almost $30,000 — the long-term savings were nearly twice as much as the extra upfront expense! That’s not the only way a higher down payment will save you money, though.

A higher down payment usually translates to a lower interest rate on your mortgage.

A higher down payment usually translates to a lower interest rate on your mortgage, because investing all that money upfront shows the lender you are committed to the home. In addition, if your down payment is 20 percent or more of the purchase price, you may save even more money because you will not have to pay for mortgage insurance.

The more savings you have for a down payment, the easier it will be for you to qualify for a mortgage. If you do not have a lot of cash on hand for a down payment, however, you may still be able to qualify through a government program.

  • The FHA loan program allows you to get a mortgage with a down payment as low as 3.5% of the purchase price, if you qualify.
  • The VA loan program allows members of the armed forces and veterans to get a mortgage with no down payment at all.
How much you have saved is an important factor in deciding which loan option is right for you.

Points

Besides the down payment, there is another way to pay money upfront to lower your costs: discount points. Generally, one point is equal to 1 percent of the loan amount, and you can negotiate how many points you wish to pay in increments of one-eighth of a point, as in these examples:

Example – Total Loan Amount: $100,000 One-eighth of a point = 0.125% of loan amount = $125 One point = 1% of loan amount = $1,000 Two and seven-eighths points = 2.875% of loan amount = $2,875

Paying discount points lowers your interest rate because you are effectively paying off interest in advance. It can work the other way, too: Your lender can credit points to you to pay for the closing costs of the mortgage, which then raises your interest rate.

Either way, points are negotiable. You pay them at closing, just like the down payment, and they affect the total cost of your mortgage, just like the down payment. So what’s the difference?

The Advantages of Each

Down Payment

  • Paying a larger down payment immediately increases your equity. This will especially benefit you if you sell your home within a few years.
  • If your down payment is 20% or more of the purchase price, you can avoid paying extra money every month for mortgage insurance.

Discount Points

  • Paying points decreases your interest rate, which leads to enormous savings over the life of the loan.
  • Points may be tax deductible, whereas your down payment is not.

Which is better?Choosing whether to put more money in your down payment or invest in more discount points is a complex task that depends very much on your specific situation. Our Loanwise specialists will be happy to guide you through the process.

View Sources
  1. Consumer Financial Protection Bureau. (n.d.). What Are (Discount) Points and Lender Credits and How Do They Work? Retrieved from http://www.consumerfinance.gov/askcfpb/136/what-are-discount-points-and-lender-credits-and-how-do-they-work.html
  2. Lewis, H. (2016, March 2016). Mortgage Down Payment - What Is It, Who It Goes to and Where It Comes From. Retrieved from http://www.bankrate.com/finance/mortgages/down-payment-1.aspx
  3. Smith, L. (2016, May 26). Mortgage Points: What's the Point? Retrieved from http://www.investopedia.com/articles/pf/06/payingforpoints.asp
  4. Zillow.com. (n.d.). Down Payment: How Much You Should Save to Buy a House. Retrieved from http://www.zillow.com/mortgage-learning/down-payments/
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