Pros and Cons of Making a Small Down Payment for a House in California

California is an expensive real estate market, especially in and around the coastal metros of Southern California and the Bay Area. As a result, many home buyers seek ways to make a small down payment. There are both advantages and disadvantages to making a smaller investment, so it’s important for home buyers to understand both sides of the issue.

In this article, we will explore the pros and cons of making a small down payment when using a mortgage loan to buy a house in California.

Advantages of a Small Down Payment

The advantages of making a smaller down payment are somewhat obvious. For one thing, you don’t have to save as much money to put toward your purchase. This means you can buy sooner rather than later. So let’s explore these and other benefits of making a small down payment on a California home purchase.

1. Lower upfront costs

The down payment is the largest upfront expense associated with a home purchase. There are other upfront costs as well, including home inspections, mortgage-related fees, etc. But the down payment makes up the bulk of the upfront when buying a home in California. So if you make a smaller down payment, you can greatly reduce the amount of money you have to come up with to close on your mortgage loan.

2. More cash on hand

Putting less money down also frees up that money for other uses. For example, if you make a smaller down payment on a home purchase, you will have more money to put toward moving expenses, furnishing the house, making your first few mortgage payments, etc.

Disadvantages of a Small Down Payment

There are pros and cons associated with almost all mortgage-related choices. And this is true for down payments as well. While a smaller  investmen can free up cash and reduce your upfront expense, it also comes with certain downsides and disadvantages. So let’s take a look at them.

1. Higher monthly payments

When you make a smaller down payment, you wind up borrowing more money from the mortgage lender. This will result in a higher monthly payment.

When creating your home-buying budget, you can use a mortgage calculator to see how different down payment amounts will affect your monthly mortgage payments. In addition to helping you create a budget, these calculators can help you understand the long-term costs associated with the loan, on a month-to-month basis.

2. Private mortgage insurance

Borrowers who use a single mortgage loan with a down payment below 20% typically have to pay for private mortgage insurance (PMI). PMI is usually required whenever the loan-to-value ratio rises above 80%.

This is another disadvantage to making a smaller down payment when buying a house in California. A smaller investment could bring mortgage insurance into the picture, which in turn will increase the size of your monthly payments.

But there’s an upside to mortgage insurance as well. Without it, nearly every home buyer in California would have to make a 20% down payment. That would leave the vast majority of borrowers out in the cold, since most people cannot afford that level of investment.

Mortgage insurance makes it possible to buy a home in California with a small down payment, thereby removing one of the biggest obstacles to homeownership.

3. Higher interest rates

Making a small down payment might also lead to a higher interest rate on your mortgage loan. When home buyers put less money down up front, they are increasing risk for the bank or lender that’s making the loan. As a result, you might be charged a higher mortgage rate compared to a borrower who puts more money down.

The interest rate is one of the four primary components that make up the monthly mortgage payment. So when you take on a higher interest rate, you end up increasing the size of your monthly payments as well. It’s a trade-off.

In the End, It’s All About Priorities

Some borrowers are unable to save up enough money for a large down payment. And that’s understandable, when you consider the relatively expensive nature of the California real estate market. The point of this article is not to encourage you to make a smaller or larger down payment, but to help you understand pros and cons on both sides.

Ultimately, it comes down to your financial situation and your long-term priorities. If you can’t afford to save up for a 20% down payment, you have little choice but to put less money down. The key is to understand how this could affect you over the long-term, compared to saving up for a larger down payment.

On the other hand, some home buyers in California have the option of making a smaller or larger down payment. In these cases, borrowers should weigh all of the pros and cons associated with a smaller versus larger investment. In many cases, it makes sense to put down at least 20%, to avoid private mortgage insurance and to reduce the monthly payments. But again, not every home buyer is in a position to do that.

Ready to Explore Your Mortgage Options?

As a mortgage broker, we work with a large number of lenders. This allows us to offer a wide range of mortgage products and programs to our clients. Some of these loan options have flexible requirements when it comes to the down payment.

If you would like to learn more about the mortgage options available to you, please contact our staff. We can review your financial situation, including your income and budget, to help you choose the best financing strategy.