Low Interest Rates or Bigger Down Payment: What’s the Best Approach?

Buying a home is one of the most difficult decisions anyone can make. The right house can be a good investment or a money sink. Finding the right home isn’t about making sure there are enough bedrooms or that the backyard isn’t too big: it’s knowing if it makes sense financially.

One of the biggest factors that come up when people are house hunting is if they should buy now while interest rates are still low or save for a bigger down payment. A larger down payment can affect everything from your total monthly payment to how much you can qualify for. However, interest rates are still at historic lows and only seem to be rising.

Read below to see if you should buy now while interest rates are still low or wait until you have a bigger down payment.

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Buy While Interest Rates Are Low

Recent trends show that interest rates are only likely to go up since the Fed has already increased rates twice. Even a percentage point can mean a huge difference in your mortgage. For example, a $100,000 loan at 6.25% and a $100,000 loan at 5.25% would mean a $60 difference per month and a $14,000 difference in interest paid.

However, the fear of rising interest rates might make people more likely to make an impulse purchase or buy a house that doesn’t suit their needs.

Wait to Save for a Down Payment

One of the only ways to decrease your monthly mortgage payment is to put down 20% or more. When you have less than 20% equity in your home, lenders charge you private mortgage insurance or PMI. PMI pays for the possibility that you default on your loan and reimburses the lender for any costs they incur.

PMI typically costs between .5 to 1% of the total mortgage each year. For example, if you have a $150,000 mortgage, you’ll pay between $750 and $1,500 each year until you reach 20% equity. If you wait until you get a big enough down payment, you can avoid PMI altogether.

The best way to compare is to use a mortgage calculator to see what your monthly payment would be if you bought now compared to if you wait until you have a bigger down payment.

However, there are a few unknown circumstances that make this comparison difficult.

“For example, if interest rates rise, then home prices may decline or stop increasing,” says Julie Rains of Investing to Thrive. “In addition, by waiting, you may discover that you’re ready to move to a new city — and you’ll save by not having to pay realtor fees, closing costs, etc. twice.”

Another reason to delay buying is to increase your credit score. The higher your credit score is, the lower interest rate you’ll receive. It can take at least a few months to increase your score, which can be enough time to round up a larger down payment. Your credit score can also influence how much you pay in PMI and homeowner’s insurance, Rains said.

Now might be the best time to buy if you’re ready for a home and have found the perfect option. However, if you’re buying out of fear, then waiting might be best. Talk to a realtor and see what the options are in your neighborhood. You might find your dream home or realize you still need more time to decide.