A Financial Planning Guide to Down Payments

I recently wrote about the importance of considering your overall financial status and goals when making a Carlsbad home purchase. It’s a big decision and there can be huge financial implications, both in the near term and down the road.

Most buyers, unless they qualify for 100% financing or obtain gift money, will allocate a large chunk of cash to the down payment (up to 20% or more of the purchase price; with detached homes starting around $500K in Carlsbad we are talking $100,000!). And the decision of how large a down payment to make on your home purchase is not just about making a competitive offer, but may have huge implications on your big-picture financial situation. This decision requires a careful analysis and depends on your unique set of circumstances. So I got some information from a friend of mine, Paul Parotti, a financial planner, and wanted to share this. With the help of a qualified real estate agent, financial planner, mortgage professional and possibly a CPA, buyers should look at the following factors when making this decision:

How will the down payment expense affect your nest egg? Tying up too much of your net worth in your home would create major problems if you were to lose your job or encounter some other financial difficulty. For those who think they will always have the option of cashing out excess equity by refinancing, consider that mortgage standards on cash out refinances are much more stringent than on purchase transactions, with lower loan-to-value allowances and stricter borrower credit requirements. Even if you do qualify for a cash out refinance, closing costs may be several thousands of dollars. The bottom line: it’s best to keep enough cash available to float you for six months or more, just in case.

How will my personal investing situation be affected? Historically, the stock market and some other investments have produced returns exceeding mortgage interest rates. The math is simple: if you can take out a mortgage at 6% but could earn a return of 10% on another investment, then every extra dollar you use for your down payment carries an opportunity cost of 4%. This analysis requires a long-term outlook, though. Too many people have been burned over the past few years by overleveraging their homes in the hopes of achieving a quick windfall by investing their excess cash in the stock market. Working with a qualified financial planner to project different investing scenarios will help you make the best decision.

Where are the down payment funds coming from? This is really a question of taxation. If you have to liquidate stock, real estate, or any investment that may cause you to incur capital gains taxes then this may be a strong argument for a smaller down payment. Talk to your CPA and financial planner about your options and the implications. How will my mortgage terms be affected? Some lenders offer lower interest rates with larger down payments. In addition, if your down payment is less than 20% (common for many buyers especially in high priced areas like the Carlsbad real estate market) then you will likely be required to purchase mortgage insurance, which will increase your monthly payments. Ask your mortgage professional for a side-by-side comparison of interest rates and payments with different down payment scenarios.

How much of my mortgage payment will be tax-deductible? While in many cases mortgage interest and mortgage insurance are tax deductible, this is not always the case. On higher loan amounts and some cash out refinances some of your mortgage interest may not be deductible. Also, the mortgage insurance premium tax deduction carries household income limits. Don’t assume that ALL of your mortgage interest or mortgage insurance premiums are deductible; talk to a CPA.

A prudent buyer will take the time to analyze all of these factors before leaping into a quick decision on how much of a down payment to make. After all, your home may be your largest asset and your mortgage may be your largest debt. The decisions on which home to purchase and how to structure your down payment and mortgage can have lifetime financial implications totaling anywhere from thousands to literally millions of dollars.

Take the time to consult with your REALTOR, financial planner and other real estate professionals. It’s your money- make the most of it. Paul Parotti can be reached at (714) 424-9440 (office), (949) 466-7519 (cell) or via email at Paul@ifsplanning.com.

Why not find out how he can help YOU with your financial planning for a better future?

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If I can provide more information about Carlsbad and surrounding areas, or the housing market in general, or otherwise assist you in your homes search, please contact me by phone or text at (760) 840-1360
or email me at JDowler@remax.net.

All content copyright © 2007 Jeff Dowler Carlsbad Homes and Real Estate Tidbits