Posted on: 04th Aug, 2009 01:56 pm
Hello, I am a first time home buyer and wanted to understand which loan scenario is financially better:
Assumptions 400K home price, nominal 20% down, 30 year fixed
Scenario 1:
Down: 40%
Interest Rate: 5.25%
Loan Amount: 240K
Scenario 2:
Down 20%
Interest Rate: 5.25%
Loan Amount: 320K
Prepayment in the first five years: 80K
Under this scenario, I want to understand which one would be financially better - we can assume that closing costs are the same for both. The way I look at it, scenario 1 reducing the loan principal upfront but the loan is assessed for 30 years while scenario 2 has higher starting principal but with prepayment, the effective loan period is reduced from 30 to lets say 20 years. Running the numbers, I get a lower total cost of interest on scenario 2 than scenario 1.
Is this reasoning correct? Any thoughts/opinions are highly appreciated.
Assumptions 400K home price, nominal 20% down, 30 year fixed
Scenario 1:
Down: 40%
Interest Rate: 5.25%
Loan Amount: 240K
Scenario 2:
Down 20%
Interest Rate: 5.25%
Loan Amount: 320K
Prepayment in the first five years: 80K
Under this scenario, I want to understand which one would be financially better - we can assume that closing costs are the same for both. The way I look at it, scenario 1 reducing the loan principal upfront but the loan is assessed for 30 years while scenario 2 has higher starting principal but with prepayment, the effective loan period is reduced from 30 to lets say 20 years. Running the numbers, I get a lower total cost of interest on scenario 2 than scenario 1.
Is this reasoning correct? Any thoughts/opinions are highly appreciated.
stolia1
Welcome to the forum
I think you are just considering the savings on interest. One other factor I woudl consider is, if you do 20% down and if you invest another 20% and if you can earn more than 5.25% then what will happne?
Thanks
Welcome to the forum
I think you are just considering the savings on interest. One other factor I woudl consider is, if you do 20% down and if you invest another 20% and if you can earn more than 5.25% then what will happne?
Thanks
Hi sunnyca,
Yes, that is true. If you have other investment options that earn more than the mortgage interest rate, then one would try to reduce the down as much as possible, though you do have to consider risk of investing as well.
However, lets say, if there is cash available and its earning potential is less than the mortgage interest rate, then should one make a larger down payment or make prepayments with a regular down. With the larger down, your starting loan amount is lesser but amortization period is 30 years, whereas with a regular down and prepayments, your starting loan amount is higher but the amortization period would be less - thus saving on the cost of interest and effectively reduce your total cost of home purchase
Am wondering if I am missing some other opportunity costs or other aspects.
Yes, that is true. If you have other investment options that earn more than the mortgage interest rate, then one would try to reduce the down as much as possible, though you do have to consider risk of investing as well.
However, lets say, if there is cash available and its earning potential is less than the mortgage interest rate, then should one make a larger down payment or make prepayments with a regular down. With the larger down, your starting loan amount is lesser but amortization period is 30 years, whereas with a regular down and prepayments, your starting loan amount is higher but the amortization period would be less - thus saving on the cost of interest and effectively reduce your total cost of home purchase
Am wondering if I am missing some other opportunity costs or other aspects.
stolia1
Cash is always king
So havign said that, if I were you I would pick option two.
You will probably feel more secure having cash in bank which is accessible when you need it and also ability to pay off your loan if you want.
Having cash in hand may come to use for emergency situation.
One more thing to think about would be to work hard to pay that loan sooner but with out loosing the sense of security
But thats me. Some for sure may not agree with me on this.
If you consder you are goign consider yoru house as an investmnet then in thsi market, you will nto see the return on investment quckely.
Lot of ways to look at this situation, but this is a good problem to have.
Cash is always king
So havign said that, if I were you I would pick option two.
You will probably feel more secure having cash in bank which is accessible when you need it and also ability to pay off your loan if you want.
Having cash in hand may come to use for emergency situation.
One more thing to think about would be to work hard to pay that loan sooner but with out loosing the sense of security
But thats me. Some for sure may not agree with me on this.
If you consder you are goign consider yoru house as an investmnet then in thsi market, you will nto see the return on investment quckely.
Lot of ways to look at this situation, but this is a good problem to have.