If you’re ready to venture into real estate investing, a crucial first step is to secure the right down payment on a property. But that immediately brings up several questions:
- How much money should you aim for?
- What are the best ways to effectively save for a down payment?
- How does a down payment affect interest rates?
Real estate is already a competitive space for investing. You want to put yourself in the best position to profit from your investment.
So whether you plan to flip the property and sell right away or hold onto it to rent out, you should know how your down payment will affect how much you’ll pay (and profit) in the long run.Get started on your mortgage loan with Park Place Finance.
Let’s start simple: A down payment is the initial cash payment to secure the mortgage loan and property.
Down payments are a percentage of the purchase price and the amount required will vary.
The required amount depends on factors such as your chosen mortgage type, financial situation, and—most importantly—the type of lender.
The amount you end up putting down a property will affect the mortgage loan, the property you’re able to purchase, and yes, your interest rate.
For example, if you opt for a larger down payment, you may be able to access a more valuable property and, indeed, secure a lower interest rate.
However, there may also be valid reasons for choosing a smaller down payment.
Let’s delve into how your down payment can influence the terms of your loan.
The size of your down payment directly influences the interest rate set by your lender.
A larger down payment can lead to a lower interest rate, as it indicates to the lender that you’re at a lower risk of loan default as a borrower.
However, it’s important to note that the interest rate is also determined by:
- The loan type you choose
- Your credit score
- Loan-to-value ratio
- After-repair value of the property
- Your debt-to-income ratio
In the case of hard money lenders, as wise investors tend to choose to work with, they set their own loan terms. If you’re an experienced flipper and have a clear plan to achieve a favorable return on your investment, you may be able to negotiate a more favorable rate.
Even taking these other factors into consideration, the bottom line is that the more you’re able to put down on a property, the better your interest rate is likely to be.
Just as it will often result in a lower interest rate, a larger down payment usually means smaller monthly payments since the balance of your overall loan is less.
Conversely, opting for a smaller upfront payment could result in a higher interest rate on your loan and higher monthly payments.
This will all also depend on your investment strategy and whether you plan to buy and hold or immediately flip and sell the property. You may want the lowest monthly payment in order to save on the amount you pay while you’re renovating the space. A higher down payment in order to save on monthly interest could be worth it for your situation.
There are distinct advantages to both large and small down payments, one of which being the interest rates we already discussed.
But weighing these benefits against your personal financial circumstances and goals is crucial before deciding which way you want to proceed.
- Lower rates: As we’ve already discussed, the general rule is the higher down payment, the lower the interest rate.
- Avoids private mortgage insurance (PMI): Certain mortgage products require mortgage insurance—an added cost on each monthly mortgage payment. For most conventional loans, a minimum 20% down payment cancels out the need to pay PMI. This is another reason that investors often choose to work with private lenders.
- Debt-to-income (DTI) ratio benefits: DTI represents how much you owe (your debt) vs. how much money you earn (your income). By putting more down, your DTI is better, which means your ability to borrow in the future is improved.
- The ability to buy sooner: It’s nice to say that you’ll just save a bigger down payment; it’s another thing to actually do it. Depending on your income, you might have to wait a long time to save up for a proper down payment.
- Savings: If all of your money has gone to a down payment, that doesn’t leave much for repairs and renovations. This is why your investment plans should be outlined well ahead of time to ensure you have enough to make the project profitable.
- Other ventures: New investors shouldn’t make the mistake of tying up all their funds in an investment project. Don’t tank all your capital into one down payment and not have enough left for other needs in your life.
Down payments for an investment property can vary between 10-30% depending on whether you work with a conventional or private lender.
If you’re new to investing, both a conventional and private lender may require a higher down payment to mitigate any risk on your investment.
Besides the down payment, buyers also need to allocate funds for closing costs, which encompass various fees associated with the transfer of ownership from buyer to seller.
Generally, closing costs amount to approximately 2-7% of the home’s value.
Although a down payment is undoubtedly a crucial step in your investment, it’s still only one piece of the overall financial picture.
Your down payment will affect other aspects of your purchase power, such as how much you can spend on a property and the interest rate on your loan.Get started with your hard money loan today.