Are you trying to decide between a low down payment and one that covers at least 20% of your home’s purchase price? You might think the only effect this decision has on your purchase is the amount you need to borrow, but it also affects the interest rates lenders offer you.
Typically, the larger the down payment, the less risk you pose to a lender. Your down payment is your investment in the home. It shows the lender that you have a vested interest in the home purchase. In other words, you are more likely to make sure you make your payments on time if your own money is at risk. If you don’t make a large down payment, you might not worry as much if you can’t make your payments any longer. You don’t have your own money at risk.
Your down payment affects your loan in ways you may not even realize, as we discuss below.
Lenders Use Risk-Based Pricing for Interest Rates
Lenders usually use what is called risk-based pricing. In other words, the higher your risk, the more they will charge you. This pertains to the interest rates as well as the fees a lender charges you. The more risk you pose to a lender, the more they will charge you – it’s a direct relationship.
One of the first areas lenders look at is your credit risk. The lower your credit score is, the more risk you pose to a lender. Beyond the credit score, though, lenders also look at your down payment. In fact, a larger down payment can serve as a compensating factor for a borrower that has a low credit score. If the lender looked at the credit score alone, they might not approve you for the loan. But, if you have 20% to put down on the home, the lender may let that offset the low credit score, giving you the loan. Not only will they give you the loan, but they may not increase your interest rates as much as they would if you didn’t have the 20% down payment.
You May Have Fewer Options
When you put only a little money down on a home, lenders tend to get a bit restrictive with their offerings. For example, you may only have one choice for a loan and its subsequent interest rate. If you were to make a large down payment, though, you may have several loan programs at your disposal, each of which has their own interest rates.
With fewer options, you may not be able to shop around for the best deal as much. With a higher down payment, though, lenders want your business. This may give you more opportunity to shop around and find the deal that works best for you. It’s always better to have more options available to you. This allows you to find the loan that works the best for you now as well as into the future.
You May Have More Bargaining Power
Basically, what a large down payment does for you is give you more negotiating power. A lender will provide you with quotes for interest rates. Do you have to take them at face value? You don’t! If you have bargaining power (good qualifying factors), you may be able to get the lender to lower those quotes. Of course, other qualifying factors can do the same thing, such as a high credit score or low debt ratio, but there’s something about investing in the home yourself that makes lenders want to bargain with you.
If you have the opportunity to make a large down payment on a home, do it. You will have lower payments, more favorable terms, and likely lower interest rates. If you aren’t sure about the effect that a down payment can have on your rates, shop around with different lenders. Give them different scenarios for your down payment and see just how much money you can save when you put more of your own money down on the home.