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The low-down on down-payments

by David M. Brown on Aug 4, 2017

"The down payment for your home purchase really depends on the type of loan, your credit score, if you are using a down-payment assistance program and the price" said Dax Ramirez a real estate agent who specializes in first-time and out-of-state homebuyers for Keller Williams Northeast Realty from its Anthem office. 

Depending on the lender and the loan program you’ve selected, the downpayment can be as low as 3.5 percent annually for a Federal Housing Administration (FHA) loan and as little as 5 percent for a  conventional mortgage loan, said Paris Davis, vice president and Northwest Arizona Retail Banking Division manager for Washington Federal.

Financial partnership

“The lower the down-payment makes you a bigger risk to the lender,” Davis said. “Lenders like to see the consumer with ‘some skin in the game.’ This transaction will be a partnership for multiple years and lenders do not want, nor can they afford, to assume 100 percent of the risk.” 

Typically, lenders require higher than average credit scores and 20 percent [down] for a conventional mortgage loan, Davis said. These are typically fixed-rate and not issued, guaranteed or insured by a government agency.

Private Mortgage Insurance

If the buyer wants to put less than 20 percent down on a conventional loan, he or she will almost always need to have private mortgage insurance (PMI) which partially insures the lender and the title-holder of payment in the event of default.

Some lenders offer a higher interest rate for the lifetime of the loan in lieu of the PMI requirement, so research your potential companies. “Not all lenders charge the same interest rates, fees and service costs,” Davis added. “The consumer needs to shop for the lender that meets their individual needs.”

Generally, PMI can be dropped from a conventional loan when the buyer’s loan to value (LTV) reaches 80 percent as determined by the lender. Avoiding this monthly payment can provide significant cost savings even in the first year of the loan.

“This higher down-payment improves the chances that the loan will be approved, reduces closing fees, allows for a smaller monthly mortgage, provides immediate substantial equity in the home and carries a lower interest rate,” she said.

Various types of loans

However, there are many variations that help consumers pay part of their downpayment. Ramirez has seen buyers use the ‘Home in 5’ federal down-payment assistance program and pay just 2 percent out of pocket total for closing costs and inspections. These are loans from FHA, an agency within the U.S. Department of Housing and Urban Development; they normally require 3.5 percent down and appraisal and home inspection costs.

Designed for low- to moderate income consumers, FHA loans require a credit score of 580 or higher to qualify for the 3.5 percent terms. Those with lower scores of 500−579 will have to come up with a 10 percent downpayment, Davis said.

While FHA home may allow a consumer to move into a home faster than with other plans, the consumer must consider the possible cost additions such as higher interest rates and fees. “These fees may be rolled into the loan amount but cost the consumer even more," she noted. 

In addition, because FHA loans are guaranteed or insured by a government agency, PMI is required for the life of the loan; it cannot be withdrawn. And regardless of the down-payment amount, every FHA loan requires an upfront premium of 1.75 percent of the loan amount as well as an annual premium.

In contrast, Veterans Administration (VA) loans offer veterans a no-downpayment option and a no-mortgage-insurance requirement, while United States Department of Agriculture (USDA) loans are for homebuyers in rural locations who may not qualify for conventional loans, Ramirez said.

Allowable “gifts”

Down-payments can be paid as a gift from family or friends for both conventional and FHA loans, Ramirez said. FHA also may allow gifts from a friend or a government down-payment assistance program.

But note: “It’s important the consumer understands the down-payment gift may help them with the closing costs but may not help them with the loan-approval decision,” Davis said. “Underwriters want and need to ensure the consumer can afford the home and the monthly payments. They will ask for documentation to ensure the gifted funds are actually a gift and not a loan that will need to be paid back.”

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