Today’s mortgage rates are low enough to make borrowers salivate. Freddie Mac (Stock Quote: FRE) says its survey puts the average 30-year, fixed-rate loan at 4.71%, the lowest in at least 38 years. The BankingMyWay.com Survey puts the number at an enticing 4.955%.
The low rate presents borrowers with an intriguing question: Should you make a big down payment to keep your loan as small as possible? Or should you borrow every penny you can while rates are in the basement?
Most lenders today require down payments of 20%, while a few years ago it wasn’t hard to find a zero down-payment loan. A bigger down payment reduces the lender’s risk by ensuring a property could be sold for enough to cover the borrower’s debt.
Many borrowers struggle to come up with 20% down payments. But others have lots of savings, or substantial equity in the home they sell in order to buy a new one.
Deciding whether to put down 30%, 40% or 50% hinges on several factors.
Imagine a person who is buying a $400,000 home. This buyer could qualify for a $320,000 mortgage, putting down 20% or $80,000. But suppose the buyer could afford a $200,000 down payment, reducing the loan to $200,000.
Putting down an extra $120,000 is like investing that sum at a yield equal to the mortgage rate, since it would reduce the borrower’s interest costs. If the mortgage charged 4.8%, the bigger down payment would, in effect, earn 4.8%.
Over the long term, the borrower might well earn more than that in a good mutual fund investing in stocks. But there’s a risk of losing money in stocks, while putting the money into the home would provide a guaranteed 4.8% return.
Compared to other safe investments, 4.8% looks pretty good. According to the BankingMyWay.com Survey, five-year certificates of deposit average just 2.253%, while money market accounts yield just 0.385% and savings accounts only 0.22%. A 10-year U.S. Treasury note yields 3.47%.