How Much Do I Need for a Down Payment?

 

The down payment on a property can be confusing, especially to a first-time homebuyer.  The down payment may range from 0% (for a Veteran’s Administration loan) to 30% for a commercial property (which can include multi-family houses with more than 4 units.)

Most people know the rule of thumb that you must put 20% of the purchase price down in order to avoid being required to buy Private Mortgage Insurance–an extra expense which is nice to eliminate if you are able.  A standard  80% Loan-to-Value loan may also reassure the seller that you have the means to actually purchase the house, while a low or zero down payment may make the seller nervous about the buyer’s financial status. In a seller’s market like Northampton real estate, a buyer will want to present the strongest offer they can.

While most offers will include a mortgage contingency that  protects the buyer, the seller may worry about taking the house off the market for the period of time it takes to get a mortgage commitment from the buyer’s lender, and this can be nerve-wracking if there is uncertainty. From the lender’s perspective, borrowers who have been able to save the funds for a down payment are less likely to get into payment troubles later on. Saving for a down payment requires budgetary discipline, repaying a mortgage also requires budgetary discipline, and the one carries over to the other.  Of course, this assumes that the down payment is saved, not borrowed.

The down payment on a home mortgage is the lower of sale price and appraised value less the loan amount. It is not the same as the borrower’s cash outlay if some of that outlay is for settlement costs, which is usually the case. Land can be part or all of the down payment.

A minimum down payment, expressed as a ratio to the lower of sale price and appraised value, means exactly the same thing as a maximum loan-to-value or LTV. For example, if the property value is $100,000 and the down payment $25,000, the down payment ratio is 25% and the LTV is 75%. Legal and regulatory requirements, are usually specified in terms of a maximum LTV rather than a minimum down payment because the LTV is less vulnerable to misunderstandings.

There are also limits on WHERE the down payment funds come from.  A gift from Aunt Mabel is great, but will it satisfy the bank?  Here are some legitimate sources of down payment money:

Home Seller Contributions:  These are not allowed, because of a presumption that such contributions will be associated with a higher sales price. However, subject to limits, home sellers are allowed to pay purchasers’ settlement costs. This reduces the cash drain on purchasers, allowing more of it to be used as down payment.

Lender Contributions Granted in Exchange For a Higher Interest Rate: These are not allowed either. However, cash-short borrowers can select a relatively high-rate loan that carries a rebate or “negative points,” and the rebate can be used to pay settlement costs. This reduces the borrower’s required cash without affecting the down payment.

Cash Gifts From Home Sellers, Builders or Other Parties to the Transaction: These are not allowed because of the presumption that the gift affects other parts of the transaction, especially the sale price.

Cash Gifts From a Relative or Live-in Partner Who Can Document the Source:  These are acceptable as down payment funds. However, the lender must be convinced that the gift is not a disguised loan with a repayment obligation that might reduce the borrower’s ability to repay the mortgage.

Buyers, do your homework!  Find out what kind of loan you may be able to obtain—there are many government programs which require a lower down payment.  Farm loans, FHA—ask your agent and your banker what you may need for a down payment, and be prepared!

 

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