Down Payment
It used to be that if you didn’t have at least 20% of the home purchase price ($20,000 on a $100,000 house) saved for a down payment, you couldn’t buy a home. Those days are long gone, and you can now buy a home with 5%, 3% or even 0% of the purchase price.
Bigger Down Payment Equals Cheaper Loan: the more money you can put down:
- The lower your monthly mortgage payment will be
- The more equity you will have
- Often, the lower interest rate you will pay on the loan.
How To Do The Math: So if you have a 5% down payment, you are borrowing 95% of the home purchase price from the lender. The 95% number is often called the Loan To Value or LTV and is used to evaluate the risk of the loan.
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Risk: From the lender’s perspective, the more money you put down when you buy, the more likely you are to keep paying the mortgage even if times get tough, so the less risky the loan.
Over the many years of mortgage lending, lenders discovered that if you didn’t put down much of a down payment, you aren’t losing as much of your own money in a foreclosure and are therefore more likely to walk away from the property if you are having problems making payments.
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Avoiding Defaults: Lenders don’t want to foreclose; it is expensive and time consuming, so they’d much rather lend money to people who look like a good risk. That’s why they offer better interest rates and require fewer additional costs like mortgage insurance (PMI) to people who invest at least 20% of the home purchase price, in their own money, at the time of the sale.
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The Magic Number is 20%: So if you want the cheapest loan, one part of figuring how much you can afford is to look at how much money you have for a down payment (and to cover closing/settlement costs). You will need at least 20% of the purchase price in order to qualify, and not have to also buy private mortgage insurance (PMI).
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No Silver Spoon? Most first-time home buyers don’t have that kind of cash, and there are lots of options if you don’t:
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FHA and VA loans
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Private Mortgage Insurance (PMI)
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Community Programs requiring little or no down payment
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Secondary Loans for the percentage of the down payment not in cash (these are often called 80-10-10s, or 80-15-5s, etc. where 80% is the first mortgage, 15% is the second mortgage, and 5% is the down payment.
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100% Financing: some lenders offer loans requiring zero down payment. These loans usually have higher interest rates to compensate for the increased risk of foreclosure, but they can be a good solution if you have a stable income but little savings.
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Down Payment Options:
- Assistance Programs & Low Down Payment Loans: Between the dozens of community, government and national programs helping low-income, minority or immigrants to buy houses, and the many low cost and low down payment mortgage options offered by lenders, it is easier than ever before to buy a home without having to save up big amounts of money.
- Keep Renting and Save: If your rent is low and you are able to save some money each month, it can be worth it to keep renting while you build up a down payment which will allow you to have a lower mortgage payment.
- Borrow Money from Family: Many first-time homebuyers either receive money from their family as gifts or as loans to help with a down payment. Many parents are also willing to sign on as co-borrowers for a mortgage.
- Private Mortgage Insurance (PMI): Tens of thousands of homebuyers each year gets mortgages for more than 80% of the home purchase price, even without the help of an assistance program. Lenders are happy to write loans for these higher amounts because as part of the loan, they then require the buyers to purchase PMI, which protects the lender in case the buyer can’t make the payments.
It is an additional amount the borrower has to pay each month on top of the mortgage loan payment, but it doesn’t last forever. As soon as your equity reaches 20% (23% in cases where there hasn’t been a strong payment history), your lender has to cancel the PMI.
- Renting with an Option to Buy: This may not be available in the area you wish to buy a home, but a real estate agent may help you find a property like this if it is.
A Bit Extra Each Month: Basically, you pay a somewhat higher rent each month for a set period of time, and the extra amount is considered your down payment. At the end of that period, the renter makes a decision about whether to buy the property or not.
This can be a great way to buy a house if you have credit problems that make it harder to get a loan, it’s also a good way to try out living in that home and neighborhood. The risk is that if you decide that you don’t want to buy the property, you will have lost the money you paid for the option.
Make It Legal: In either case, if you do lease with an option to buy, make sure you have a legal document which clearly spells out how much of each month’s payment goes toward the down payment/option and how much is rent.