If there’s one question most borrowers have when buying a home, it’s how much should they put down? The common down payment is 20%, but not many buyers have that ability. That’s okay because there are many available programs out there that don’t require nearly that much. However, will you get a better interest rate if you make a higher down payment?
We explore the possibilities below.
What Does a Higher Down Payment Do?
Your down payment is like an investment in the property. Lenders like to call it ‘skin in the game.’ When you have your own money invested, you are more likely to make good on your payments. Let’s look at an example.
Joe buys a $200,000 home. He puts 15% down on the home, which means $30,000. One year later, Joe loses his job and has to start prioritizing which bills he pays. He knows if he doesn’t pay his mortgage, he’ll lose not only his home, but his $30,000 he already invested. He also has a little more of his own money invested based on the last 12 payments he made. It’s not much, but adding it to the $30,000 makes Joe motivated to make his mortgage payments and work out deals with the other bills he can’t pay.
Jan buys a $150,000 home. She puts down 5% or $7,500. One year later, Jan loses her job. She can’t make ends meet. While, her initial $7,500 investment is a sizeable amount of money, she just can’t make it work. She ends up walking away from her home because the payments are just too high for her to make it work.
These examples are hypothetical, but they show the difference in the higher down payment. It’s a higher risk for the lender when you put less money down.
The Role of the Interest Rate
So now what does the interest rate have to do with the down payment? It’s all about the risk level. The less money you put down, the higher risk you pose the lender. In order for the lender to make up for that risk, they charge a higher interest rate. This way they make money on your loan while you do make payments. If you don’t make them, they at least have the extra interest they made while you did make the payments.
Other Ways to Lower the Interest Rate
If you can’t make a higher down payment, don’t worry. That doesn’t mean you are stuck with the highest rate lenders have to offer. You can make up for it other ways. Remember, lenders look at the big picture rather than individual factors. Here are a few ways you can make it work:
- Great credit score – The higher your credit score, the more financially responsible you seem to a lender. Try focusing on your credit at least one year before you want to buy a home. Make sure all payments are on time and that your outstanding credit isn’t excessive compared to your available limits. Also, don’t apply for any new credit during the months leading up to your mortgage application.
- Low debt ratio – Try lowering your debts as much as possible before applying for a mortgage. The fewer debts you have, the more likely it is you’ll be able to pay your mortgage. This makes you look better in the lender’s eyes.
- Stable job – Ultimately, lenders like to see you at the same job for the last 2 years. This helps them have faith in your stability and ability to continue to make your payments on time.
- Increasing income – If your income steadily increases over the last 2 years, it looks favorable to a lender. Decreasing income, on the other hand, is a red flag.
You don’t have to have the perfect combination of all of the above factors, but the more you have, the better your chances of approval and/or a lower interest rate.
One last way to ensure that you get the lowest interest rate is to shop around. Each lender has different requirements and thresholds for risk. It’s up to you to get quotes from as many lenders as you feel comfortable. Usually three lenders is a good number. This way you know what the average rate and closing costs are available for your situation. You can then decide which lender will work best for you.
Maximizing your chances of a low-interest rate is done by making a high down payment if you can as well as maximizing as many of the above factors as you can. Creating that fine balance will help you have the greatest outcome when you try to get quotes for a mortgage for your new home.