Learn how down payment influences mortgage terms and interest rates

When purchasing a home, your down payment play a significant role in determining the terms and interest rates of a mortgage. Simply put, bigger is better, but here are some key ways they influence these factors:

1. Interest Rates
Lower Interest Rates: A larger down payment typically results in a lower interest rate and more loan options. This is because a higher down payment reduces the lender’s risk, making them more likely to offer a better rate. It also means you might have to to pay for extra mortgage insurance (see #4).

Higher Interest Rates: Conversely, a smaller down payment can lead to higher interest rates, as the lender perceives a higher risk of default. For example, most down payment assistance loans come with higher interest rates.

2. Loan-to-Value (LTV) Ratio
Lower LTV Ratio: A larger down payment decreases the loan-to-value ratio, which is the loan amount divided by the appraised value of the property. A lower LTV ratio is favorable and can lead to better loan terms.

Higher LTV Ratio: A smaller down payment increases the LTV ratio, which can result in less favorable loan terms and higher interest rates.

3. Monthly Payments
Lower Monthly Payments: With a larger down payment, the loan amount is smaller, leading to lower monthly mortgage payments4.
Higher Monthly Payments: A smaller down payment means a larger loan amount, resulting in higher monthly payments.

4. Private Mortgage Insurance (PMI)
Avoiding PMI: Putting down at least 20% can help you avoid paying for private mortgage insurance, which is an additional cost added to your monthly payment 
PMI Requirement: If your down payment is less than 20%, you will likely need to pay for PMI, which increases your overall monthly payment.

5. Loan Approval
Higher Approval Chances: A larger down payment can improve your chances of loan approval, as it demonstrates financial stability and reduces the lender’s risk. This is especially important if your credit is on the weak side.
Lower Approval Chances: A smaller down payment might make it harder to get approved for a mortgage, especially if other factors like credit score are not strong.

The Bottom Line

While bigger is generally better, it doesn’t always make sense.  For example, I never suggest spending every penny you have on down payment and not leaving yourself with some significant reserves for emergencies.

A conversation with a professional licensed Loan Officer is best to determined your overall finances, and what size down payment is going to be right for you. Call (651) 552-3681 today.