Should You Ever Put More Than 20% Down on a Home?

Now that the Fed has cut rates yet again, it looks like the housing market might start heating up. This means that you may finally get the chance to get a reasonable mortgage rate. Of course, reasonable is a relative term. Mortgage rates are still elevated today compared to their pre-COVID levels.

As a result, this begs the question: should you put more than 20% down when buying a home?

The recommended downpayment for a home in the U.S. is 20% because this is the amount that makes borrowers more attractive to lenders. When you put at least 20% down, you get better loan terms, a lower monthly payment, and can avoid private mortgage insurance (PMI).

But going beyond 20% is a different question. When interest rates are high (>8%), putting more than 20% down can be a no-brainer, especially if you can’t earn anywhere near that rate elsewhere. And when interest rates are low (<4%), putting more than 20% down can seem unnecessary. After all, you can probably earn more than 4% in a diversified portfolio.

But what about when interest rates are between 4% and 8%? That’s where the answer isn’t so straight-forward. It’s also exactly where we are today.

So, let’s review the pros and cons of putting more than 20% down on a home and why it’s relevant to today’s housing market.

When You Should Put More than 20% Down

To start, let’s look at a few reasons why you should consider putting more than 20% down, if you are able to.

• When Interest Rates are Higher
  • When interest rates are higher, putting more down reduces the amount of total interest you will pay across the life of your loan.
    • For example, let’s assume you want to buy a $500,000 home with interest rates at 6%.
      • If you put 20% down, you would pay $463,353 in interest over 30 years.
      • But, if you put 30% down, you would only pay $405,434 in interest over the same time period.
    • By putting 10% more ($50,000) down today, you would pay $57,919 less in total interest and $300 less per month across for each month of your 30-year mortgage! This is why putting more down can be so attractive in the long run.
  • The only difficulty with this decision is deciding what a “high” interest rate means to you. My definition is above 8%, but it’s always relative to what you can earn on your money.
• If You’re Risk-Averse
  • If you are risk-averse, you might also consider making a downpayment greater than 20%. Having a lower mortgage payment reduces the risk of a future default and makes it easier for you to save money in the interim. Of course, that extra cash you used on the downpayment could also come in handy during emergency situations. So depending on how you define “risk averse” putting more down may or may not be a good choice.
• For Peace of Mind
  • If you are someone that hates the idea of having debt no matter the interest rate, then putting more down on a home can be a way to increase your peace of mind. Though this might seem suboptimal, for a certain subset of the population, even mortgage debt causes worry. If you are one of these people, then getting your debt paid off faster can be the way to a more relaxed financial life.
• If You Are Older and Don’t Want a Mortgage
  • Lastly, if you are older and don’t want to deal with a mortgage anymore, putting more down or paying for a home in cash might be the right move. This is especially true if you don’t have as much income as you did during your working years. Mortgages have risks so by avoiding such risks in retirement you might just sleep easier as well.

While there are many good reasons to make a larger downpayment when buying a home, there can also be a few drawbacks as well.

Potential Drawbacks of a Larger Downpayment

Most of the drawbacks of a larger downpayment involve giving up optionality in exchange for paying less total interest. This loss optionality includes:

• Less Liquidity
  • When you put more down on a home, you increase the equity in your home, but also end up having less for other things. While you may not need that extra money right now, if you find yourself in need of a lot of funds within a few years, having this additional liquidity can make all the difference.
    • For example, if you experience an unlucky health outcome, having extra money outside of your home can be a lifesaver. While home equity lines of credit (HELOCs) exist to create this kind of liquidity when needed, not everyone will have access to a HELOC. 
  • Though no one can predict the future, few people regret having more liquidity.
• Missed Opportunities
  • In a similar vein, putting more down on a home means less money for other investment related opportunities. If the stock market crashes and you want to buy stocks on the cheap, you won’t be able to. While holding cash to buy the dip is generally a terrible investment strategy, locking up your extra cash in your home prevents you from taking advantage of such opportunities. 
• Reduced Tax Deduction on Mortgage Interest
  
  • For those that itemize their deductions (i.e. go beyond the standard deduction), reducing your mortgage payment can reduce the tax benefit associated with paying your mortgage interest. While losing this tax deduction sucks, please don’t miss the forest for the trees. As nice as the interest deduction is, not having to pay the interest at all is even nicer.

Overall, most of the downsides to paying your mortgage early revolve around unforeseen circumstances in your future. If you have less stability in your career or financial life, then making a larger downpayment may not be the right thing for you.

Before we wrap up, let’s look at some other things to consider when deciding how much to put down for a home.

Other Options to Consider

So far we’ve framed the option of putting more than 20% down on a home as a binary choice. You either put 20% down or you put more than 20% down. However, there are other options at your disposal that might just be the best of both worlds.

• Split the Difference
  • Instead of putting your target amount down, go half-way between 20% and your target. So, if you originally wanted to put 30% down, do 25% instead (the midpoint between 20% and 30%). This will allow you to get some of the benefits of putting down more than 20% without giving up all your extra liquidity. This is a hedged approach that may appeal to those who want to pay less interest without giving up all of their optionality.
• Make Extra Principal Payments
  • Instead of putting more than 20% down, you can hold onto that cash and make extra principal payments over time instead. This will allow you to have some extra liquidity after buying your home and give you some flexibility as well. You might need that additional liquidity in the first year, and if you don’t, then you can always start making extra payments on your own schedule.
    • Note that if you decide to go down this route, make sure that all of your extra payments go to principal only. Contact your bank to ensure that this is the case before making any extra payments.
• Put Down 20% and Invest the Rest
  • Similar to the prior option, putting 20% down and investing the rest can make a lot of sense if you believe that your portfolio can generate more income (after tax) than the interest rate on your mortgage. While this is unlikely when mortgage rates are at 6%, as rates drop further, this becomes more feasible.
  • Of course, there is no right answer here. While some would argue that 6% is too low to make extra principal payments, these kinds of decisions are always in the eye of the beholder. I think a 6% nominal return is decent and I would take it every chance I got. Others wouldn’t. That’s fine. This isn’t about who is right, but about what’s right for you.

Now that we’ve looked at some other options to consider when deciding the size of your downpayment, let’s wrap things up by discussing why there is no perfect answer when it comes to buying a home.

You’ll Never Get it Perfect

No matter how much you decide to put down on a home, the key thing to remember is that you will likely never make the perfect choice. In hindsight, you can almost always find a better decision you could’ve made compared to the one you did make.

Unfortunately, this is only true because of the benefit of hindsight. Since the future is uncertain, it’s nearly impossible to make the optimal decision in the moment. Though this is true, we still tend to judge our based on how they turned out rather than the process we used to make them.

But this isn’t the right way to look at it. Annie Duke calls this “resulting” and it’s one of the most difficult biases to overcome when evaluating our decisions.

I’m not immune either. I know I will likely fall victim to “resulting” after I buy my first home too. With interest rates set to decline further into 2025, I plan to start seriously home shopping next year. However, if I can’t get the rate I want, then I might have to put more than 20% down to get a lower rate and pay less overall interest.

Will this be the “perfect” choice? I doubt it. Maybe the market will go up a ton and I will have missed out by playing it safe. Maybe I will need that extra liquidity in a year or two. I don’t know.

These decisions are never easy to make. But accepting that you probably won’t make the perfect decision is the only way to go. 

So, happy house hunting and thank you for reading!

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This is post 424. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data