October 14th, 2014 8:45 AM by Jackie A. Graves, President
What is a down payment? When you buy a home, it is
typical for you to provide some of your own money in addition to the money you
take out on loan. The money you provide of your own is considered the “down
Homebuyers are typically required to
contribute a down payment equal to 3-20% of the sales price of the home. Zero
percent down loans are also available, though due to the subprime lending
crisis, fewer lenders are willing to lend to homebuyers who have no down
Why is a Down Payment Such an
Important Aspect of Buying a Home?
Lenders often require down payments.
And the bigger the down payment you can provide, the better. Here’s why:
larger your down payment, the less you have to borrow, and therefore, the lower
your monthly payments.
you have a very small down payment, i.e., 5% or less, you will be eligible for
fewer types of mortgages and may be charged a higher interest rate.
bigger the down payment you are able to put down, the more banks will be
willing to loan you. (And the more willing they will be to loan to you at all.)
any down payment less than 20% of the asking price, you will be asked to pay
Private Mortgage Insurance (PMI).
sometimes allow sellers to cover less of the closing costs when a buyer has a
very small down payment.
The down payment can also act as a
reality check; if you haven’t been able to save even a minimal down payment of
3-5%, you should ask yourself whether you are financially ready to buy a home.
Reflect on why you have not been able to save, and think hard about whether you
would be able to keep up with your mortgage payments, assuming you could find
100% financing. While it might be stressful to continue renting instead of
buying, think of it this way: renting is less stressful than losing your home
due to foreclosure because you were unable to pay the mortgage payments.
How Can I Buy a Home if I
Only Have a Small Amount of Money to Put Toward a Down Payment?
A limiting factor for many homebuyers
is the lack of an adequate down payment, and in the wake of the subprime
crisis, there are fewer lenders offering 100% financing. So how can you buy a
home without a significant down payment?
Save Instead of Paying Off
Debt (Assuming You Have a Good Debt-to-Income Ratio)
If you have a good job and are
concentrating on paying off debt, it probably makes sense to
put something into the savings account instead. Many people can easily handle
the debt they have and think that lenders want them to be debt free. Not so.
They just want your debt-to-income ratio to be within the guidelines. So long
as your ratios are less than, say, the mid-40% range, having a down payment
will be more important than a lower debt load. Your goal should be to accumulate
a 5% down payment.
Look Into 100% Financing (But
Only if You Feel You Will be Capable of Making the Monthly Payments)
Let’s assume that you want to buy now,
and you have a small down payment saved, say $5,000. Well, you have several
options. The Federal Housing Administration (FHA) and the Department of
Veterans Affairs (VA) have been doing 100% financing for years, although the
rate for these loans may be higher than other options. Conventional loans that
are sold to FannieMae and FreddieMac, the two giant organizations that buy most
of the loans originated these days, may offer better options. Both agencies
have introduced programs to help buyers who have scarce resources.
If you can secure 100% financing, be
aware that there is a catch. With these programs, you have to pay Private
Mortgage Insurance – PMI – and you may have to be able to contribute at least
3% of the selling price to closing costs. That’s OK. You have $5,000.
Several lenders have programs that
provide 100% financing without PMI, but the rate is correspondingly higher.
Bottom line, the differences between these programs may be minimal. Remember
that you can also eliminate PMI as soon as your home appreciates to the point
where your loan equals 80% of the new, higher, value of your home.
You can also do a “piggyback”
transaction: a 1st loan for 80% of the value, and a 2nd loan for the other 20%.
There is nothing wrong with this kind of transaction and it is very popular as
PMI is not typically required. Usually the 1st must be a 30-year fixed rate
loan, but there are a large number of fixed rate and variable rate options for
the 2nd loan.
Be Sure You are Ready
So, as you see, there are programs to
help you if you do not have a substantial down payment. But remember—these
programs will help you to secure loans, but not to make your monthly payments,
so be sure you are financially ready before taking on 100% financing.
If You are Receiving Money
from Friends or Family
Many homebuyers receive money from
friends or family to buy homes. One important note to remember: the money you
receive must be considered a gift, not a loan, or lenders will view the money
as debt. This is not hard to prove—your relative or friend typically only needs
to write a letter indicating the money is a gift, not a loan.
Remember Closing Costs,
Moving Costs, etc…
Also, keep in mind that not all of your
available money can be put toward a down payment. Closing costs, moving costs,
repairs to the new home, new furniture needs, etc., should also be taken into
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