It seems like good financial sense to put at least 20% down when you buy a house… right? That is what many banks require to get a loan. But is that a good thing for you? The numbers tell a more complete story.

When it comes to home loans banks require money down to protect themselves from losses. If the buyer stops making payments the bank will repossess the property then sell it. The down payment is a cushion for the bank in a takeover scenario even if the property drops in value. The down payment also anchors the buyer to the house since they have “something in it” too. That is good for the bank and the neighborhood.

To explore the idea of how your ending net worth changes based on how much money you put down when buying a home we ran a few simulations.

The simulations assume the following:

• The home is worth $100k at the time of purchase and grows 3% per year in value.
• Interest rates are 4.375%.
• The mortgage payment would be $500/month for a 30 year loan at 4.375% with zero down.
• The only income considered is $500/month which either goes towards the mortgage, or gets invested in the stock market.
• You start with $100k in the bank. What isn’t used for the down payment gets invested in a stock index mutual fund.
• The stock index mutual fund grows at 5% per year (which is lower than the historical average for index funds).
• Simulations do not consider PMI (mortgage insurance) that comes with some loans that don’t have enough of a down payment.
• Simulations run for 30 years.
• All other variables are not counted in the simulation since they can be assumed to be the same - real estate taxes, living expenses, etc.

Findings After 30 Year Simulation:

* the ending net worth does not total because of minor differences between income and payment

Simulation Links:

• Simulation with 0% Down
• Simulation with 20% Down
• Simulation with 50% Down
• Simulation with 100% Down
• Rent Only Simulation

In these simulations you will always be better off, after 30 years, with as low a down payment as possible. This is true regardless of whether or not home prices increase or decrease over the years. This is because we’ve assumed you are choosing between an asset that grows at 3%, (the house) and one that grows at 5% (the stock market index fund), with a borrowing cost of just 4.375%. The smaller the down payment the more that is left over to grow at 5%.

Broadly speaking if mortgage rates are below the average returns in the stock market a down payment takes away from your future net worth (a little bit).

Is a smaller down payment really worth the risk?

If stock market returns drop, all these simulations are out the window… An ending net worth of $641k with the all cash approach vs $675k with zero down is only a $34k difference. Over 30 years that is about $1,000 per, or less than $84 per month. That may not be worth the extra risk of carrying the debt. Having a home paid off does come with peace of mind.

What about the interest on the loan?

Paying interest hurts, but if the market is returning more than the interest on the loan, it is like free money (assuming you are comfortable with the risk). The simulations include interest and you can view it under the aggregate summary link or the table icon for the loan line.

What’s wrong with this picture?

Is it a good assumption to make that prices will always go up? No, of course not, that is how the 2008 crisis got started in the first place. However a 30 year time span is a pretty long period of time, enough to smooth out effects of temporary economic downturns.

Will houses and the stock market steadily go up in value 3% and 5% per year respectively? Year to year prices will fluctuate a lot. Again after 30 years things should smooth out. But, and this is a big BUT, we have no idea what real estate returns or stock market returns will be in 30 years.

What about Renting?

We threw in a “rent only” simulation just to show the effect of long term appreciation with the house. Buying a house is a form of forced savings. A substantial percentage of household net worth in the USA is in home equity.

In these simulations buying instead of renting yields upwards of $209k in extra net worth. It isn’t exactly apples to apples though… The simulation assumes rent equals the mortgage payment but rent should really include taxes and maintenance. We explored buying vs renting in more detail here.

Summary:

From a financial point of view, there are advantages to investing money rather than using it to pay for a house in cash. Most importantly, money invested in the stock market is more liquid than home equity—it is easier to sell some stocks than to get money based on home equity. Over 30% of Americans have no wealth at all other than their primary residence—and generally speaking, that is not a good thing.

However… financial decisions are not always just about maximizing long-term gains. It doesn’t make financial sense, ever, to pay for a house entirely with cash, but for some people that feels safer and fulfills an emotional need to own a home outright.

Want to play with the simulations and see how investing more or less, or buying a house worth more or less, will influence your net worth 30 years down the road? You can copy the above simulations and play around with them to see how different financial choices add to or subtract from your net worth.