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

Now that the Reserve Bank has cut rates yet again, it looks like 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 deposit for a home in NZ 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 higher interest rates.

But going beyond 20% is a different question. When mortgage interest rates are high (>7%), 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 mortgage interest rates are between 4% and 7%? 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 7%, 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 deposit 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 deposit 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 deposit when buying a home, there can also be a few drawbacks as well.

Potential Drawbacks of a Larger Deposit

Most of the drawbacks of a larger deposit 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 (HELOC) 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. Locking up your extra cash in your home prevents you from taking advantage of such opportunities. 

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 deposit 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.

• 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.

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

In conclusion, deciding whether to put more than 20% down on a home is a nuanced decision that depends on various factors, including current interest rates, your financial stability, and personal preferences. While putting more down can reduce the total interest paid and provide peace of mind, it also limits liquidity and potential investment opportunities. Ultimately, the right choice varies for each individual, and it's essential to weigh the pros and cons carefully to make an informed decision that aligns with your financial goals and risk tolerance.