Lock Up Your Money in Big Down Payment, Get Big Returns

NEW YORK (TheStreet) -- Anyone up for earning "incredible yields with no risk"?

That sounds like a come-on for an investment that in truth is loaded with risk, or maybe for an out-and-out scam. But it's not. Big yields -- 7%, 8%, maybe more -- are available, guaranteed, if you can live with tying your money up for years, perhaps decades.

That's a big "if," but this investment strategy is worth considering if you're taking out a mortgage. It's simple: Make a bigger down payment.

The gains come in several forms. First and most well known is the savings on interest payments. If the mortgage charges 4.25%, every extra dollar put into the down payment will save 4.25 cents a year on interest charges. This is a guaranteed yield, exactly like earning 4.25% in a bank account or money-market fund.

That's pretty good, since actual bank savings pay well under 1%. But wait, there's more ...

Many borrowers pay points, which are upfront interest payments, to reduce a loan rate. Since each point is 1% of the loan amount, reducing the loan by paying more down cuts the amount paid in points. On his website, Jack M. Guttentag, emeritus finance professor at the Wharton School, shows how this could raise that yield on extra down payment to 4.43% from 4.25%. The actual amount would depend on how long the borrower kept the loan, since the one-time 1% savings would be spread over the years.

Guttentag says the down payment yield could be raised further if the extra down payment reduced or eliminated the requirement to pay mortgage insurance. This insurance, which protects the lender if the borrower defaults, is waived if the when the equity in the home -- the home value minus the loan balance -- is 20% or more of the value.

In his example, the buyer of a $200,000 home who puts 5% down would pay $85 a month in mortgage insurance. Increasing the down payment to 10% would cut that charge to $58 a month, saving $324 a year. That alone is a 3.24% yield on the extra $10,000 put down. Add that to the yield earned from savings on interest and points and the total yield approaches 8%.

Granted, the stock market, if it were to continue rising as it has in recent years, might provide bigger returns. But there would be considerable risks as well, while return on the bigger down payment would be a sure thing.

As mentioned, the extra money down would be tied up in the home. To get it back you'd have to sell or take out a new mortgage or home equity loan, which would mean paying interest to get at your own money. That's not an issue with bank savings.

So an extra down payment is clearly not for next week's grocery money or a rainy-day fund. It should be viewed as a long-term investment, similar to other fixed-income investments such as bonds. You might, for example, put extra money down to enjoy generous yields until you retire. Then the money could be put into your bank account after you sell the home to downsize

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