Personal Finance Essentials
Determining the Correct Down Payments
How Much Should You Put Down?
Rethinking the Down Payment Dilemma
Conventional wisdom says to put as much money down as possible when buying a home. The financial logic says otherwise. A larger down payment reduces your loan but also reduces your cash — money that could otherwise be earning returns in investments.
Saving for a Down Payment
When saving toward a specific purchase like a down payment, investment risk should match your timeline. Consider Holly, age 28, who wants to buy a $500,000 home in two years. She has $45,000 saved and puts aside $750 per month. She needs about $62,500 for the down payment and closing costs. At $750 per month, for two years, she will accumulate another $18,200, bringing her total to $63,000 — even without earning any interest at all. She has no reason to take investment risk. The principle is simple: only take as much risk as you need to achieve your goal.
Smaller Down Payments Preserve Wealth
When you buy, there is a strong case for keeping your down payment as small as possible and investing the rest. Consider Julia and Jean, who both have $350,000 cash and want to buy a $350,000 home. Julia pays cash — no mortgage, no payment. Jean puts down $70,000 (20%), gets a $280,000 mortgage at 7%, and invests the remaining $280,000 at 10% annual returns. After the mortgage interest tax deduction, her real cost is about $1,442 per month — and her investments are generating over $1,750 per month in after-tax returns.
After thirty years, Julia’s house is worth $1,050,000. Jean’s house is also worth $1,050,000 — plus the original $280,000 she invested has grown substantially, and she has reinvested the monthly surplus throughout. Jean’s net worth is more than twice Julia’s. Carrying a mortgage and investing the difference is, over the long run, a far more effective strategy for building wealth.