The Importance of the Down Payment
One of the biggest factors in your ability to purchase a home is the down payment. By now, you have probably given some thought to the price you want to pay, can afford to pay, or have to pay for the home you want.
Let's say you estimate the price of the home you want to buy at $110,000–$125,000. Ten percent of that is at least $11,000. Most down payment requirements are 10–20 percent of the purchase price of a home. It sounds like a lot of money, and it is, but look at what you are getting.
Leverage has always been a key term in real estate. Applied to a home, it can translate into spending $15,000 to get a $125,000 house. How could you acquire so much for so little in another area of the marketplace? A house is something that will become more valuable over the years; it will not depreciate instantly like a car or furniture does.
Higher Down Payment Requirements
There is both good and bad news here. You have just read the good. The other side of the equation is that over the last several years, some lenders have clamped down on the amount of money they are willing to extend for mortgages. They insist that mortgage applicants be prepared to invest more up front.
If down payments are higher, lenders reason, homeowners in financial trouble will think twice about locking the door and heading off down the interstate; they will stay and try to work through their problems, or they'll at least stay long enough to sell the house. Homeowners with bigger amounts invested in their property will be less likely to sacrifice their investment in times of trouble.
Lenders say there is a definite correlation between loan defaults and the amount of money a borrower has invested in the home — the lower the down payment the greater the risk to the lender. Scott Yonehiro says:
One of the main reasons for the alarming rise in short sales and foreclosures is due to the 100 percent financing options with adjustable rate mortgages that became big between the years of 2002 to 2006. When properties were continuing to grow in equity and loans started to adjust, a homeowner would just be able to refinance again with no problem.
But when values started dropping and more loans were adjusting then many of the homes were underwater on their mortgages and homeowners owed more on the home then it was worth. Faced with the decision on making a substantially higher payment for a home that was losing value and no hard earned down payment was used, it became an easy decision for many homeowners to simply walk away.
Homes insured by the Veteran's Administration or the Federal Housing Authority — two agencies that provide sources of low down payment financing — usually show twice the delinquencies of conventional mortgages.
Another reason for higher down payment requirements is the existence of the secondary mortgage market — the market used to sell the loans. People don't realize that many lending institutions act as brokers for mortgages, rather than actually loaning the money for the long term to the homebuyer.
As an example, you must realize that banks accumulate deposits to invest, and then earn profit from the interest rate they lend at versus the rate they pay out as interest. A bank that pays 3 percent on a savings account will earn big dollars in a 30-year mortgage because most of what is paid back to the bank in the first half of the life of the mortgage is interest.
When banks have large deposits they look to invest their money, thus they look to purchase pools of loans that offer good rates of return. Banks that are looking for a quick return on their ability to place loans will lend money as mortgages, then sell the paper to other banks, get their capital back with a fee for acting as the originator of the loan, and start all over again.
These mortgages have to fit a profile when being offered on the secondary market. They must be no less than 80 percent of the value of the property. This insures the ultimate holder of the mortgage that if they foreclose, there is equity in the property they may ultimately own.
These agencies have demanded that mortgage lenders scrutinize down payments far more closely than they have in the past. Here, too, the reason is protection against default.
Situations That May Demand Higher Down Payments
Putting down as little as you can is usually the best way to go. Still, if you are self-employed, if you have a poor credit record, or if you are very young — with no credit history and just starting your first real job — you may want to, or have to, come up with more than the minimum a lender is requiring.
You may also have to come up with more if you want to buy a more expensive house than you can comfortably carry. A higher down payment can make lenders look more favorably on applicants who may have a poor credit history or other financial black marks against them. Consider the options listed in the following pages very carefully — and push hard to make one of them work for you.