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Why You Should Make a Big Down Payment for Your Investment Property

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Why You Should Make a Big Down Payment for Your Investment Property

12/3/2019

If you’re thinking of buying an investment property there’s one question that will quickly come up: “How much should I make for a down payment?”

Down payment requirements vary considerably across the board, ranging from the 3.5% rate that a first-time buyer may be eligible for to the 20%, or higher, that banks often require for investment properties.

Generally, down payments are something that many people struggle to make –but for investors, especially, in some cases, it makes sense to go beyond the required amount –and opt for a higher down payment.

How high are we talking? It depends! In some cases, it might make sense to put 30% down. In other cases, though, you may want to opt to only make the minimum requirement. For instance, in some markets, sourcing 30% on a $500,000 house would mean coming up with $150,000 ­–a challenging task for all but the most financially stable!

Of course, the ideal amount for a down payment varies considerably –and depends on your market, your financial situation, and your bank’s loan terms.

If you’d like to get started with investment property, it’s important to recognize that there are a few distinct benefits of making a higher down payment. Read on to find out what they are, and see whether a larger down payment is the best option for you.

Benefits of a Higher Down Payment

  • Eliminate PMI

First up, let’s take a look at Private Mortgage Insurance (PMI).

In most cases your lender will require PMI, but if you can manage a down payment of at least 20%, you won’t have to pay this additional monthly expense. The reason is simple: lenders usually require PMI for buyers who borrow more than 80% of the home’s value, and making a higher down payment will put you in a lower risk category –eliminating the need for PMI. Since these premiums usually cost from .5% to 1% of the loan, they can easily result in thousands of dollars extra per year until you build up enough equity to reach the required 20% --which means that this is one expense that’s often worth eliminating.

  • Lower Monthly Mortgage Payments

Tenants come and go, and if you happen to have a vacancy, you’ll have the pressure of trying to come up with a large payment on your own. If you have a sizable monthly mortgage payment hovering over you, this can be especially difficult.

But a larger down payment means that your monthly mortgage payments will be lower as well. Of course, when it comes to investment properties, where the goal is to generate a profit, this can help to mean the difference between a profitable year, and one where you just about break even.

  • Secure a Better Interest Rate

When you’re able to make a larger down payment, banks or lenders are more likely to give you a loan with better terms –including a lower interest rate. This, of course, means lower monthly payments, but not only that, but it also means that you’ll pay less in the long run as well since more of your payment will be going towards the principle (not the interest).  

  • You’ll Get Approved More Easily

Being able to make a large down payment is valuable to lenders. It shows that you have a long-term and vested interest in the house, since your own money is at stake. In some cases a larger down payment can even compensate for other weaknesses, increasing your chances of approval.

  • You’ll Have Better Odds Against Multiple Offers

Let’s face it, when you are up against multiple buyers, having a larger down payment ready and waiting can help you to stand out. A large down payment shows that you have your finances in order, and most lenders will consider it a very good sign.

Tips for Saving Up

While not everyone is capable of making a large down payment, especially in some housing markets, nor is it always necessary.

However, if you’d like to take advantage of the benefits that come from being able to make a bigger down payment then your best option is to start saving now.

While saving for a down payment can seem daunting, with a few good strategies your savings goal can be within your grasp.

  • Be Informed

First up, it’s important to be informed on the exact amount that you’ll need to save. Instead of arbitrarily socking away cash in hopes of reaching some unknown amount, add a dollar amount to your savings goals. It’ll make your goal far more concrete if you have a clear objective to work towards.

At the very least, take a look at online down payment calculators for an idea of what you’ll be looking at for a down payment. You’ll also want to do some research on homes in the area that you’re thinking of investing in, and speak with your bank or a financial adviser about down payment requirements and see if they can advise you on the benefits of making a large down payment.

  • Know Your Options

While a 20% down payment is common, many banks allow less –with many first-time buyers qualifying for as little as 3% down. Just bear in mind that even a small down payment could still be costly. A 5% down payment on a $300,000 home is still $15,000.

  • Know Your Credit Score

In most cases, a good credit score can help you to qualify for a lower interest rate and down payment as well. Keep in mind that it can take time to improve a low credit score, so if buying an investment property is in your future, you’ll want to start early to work on building yours up. A score of between 750 and 850 is considered excellent –and could help you to secure the best loan terms.  

  • Start Saving Early

When saving up for a down payment, your best option is to start as early as possible. Once you have a solid figure in mind, you can work backward from there to reach your savings goals. If you can, opening a separate savings account with a large windfall can help to give you the momentum that you need to grow your savings at a faster rate –and encourage you to stick with it as well. Work bonuses, any extra cash, and tax refunds can all go into this account. You’ll also want to consider automated savings plans, where a portion of your income goes directly into savings.

For more ideas on funding a down payment take a look at Nolo’s helpful article: Your Down Payment: Where Will It Come From?

If you’d like to start investing in real estate, but are struggling to come up with a sizable chunk of cash –don’t feel discouraged! Not every investor will be able to make a larger down payment, or indeed even want to. Just make sure you take the time to do your research so that you can assess the benefits of a larger down payment, and weigh them up against your own financial situation to see which approach is best for you.

Investors: larger down payment or minimum required amount? What do you recommend?