Down Payment Requirements, Issues and Considerations for Homebuyers

The down payment is the amount of the purchase price that you will not finance with the mortgage loan.

But it is actually more than that, as discussed below.  When it comes to down payment, prospective borrowers have different options and considerations to review

• Conforming requirements
• Non-conventional options
• Personal considerations

From the lender’s point of view, the down payment is a measure of the level of risk exposure that the lender must face on an individual loan program: the lower the down payment, the greater the risk exposure for the lender.

In the first half of this century, it was not uncommon for banks to demand a 50% down payment on home purchases and construction.  Eventually, that minimum down payment requirement would continue to decrease.  However, the one element that probably did the  most to bring down payment requirements to today’s lower levels is mortgage insurance.

Many borrowers complain about the expense and seeming unfairness of mortgage insurance.  Some would consider it absurd that they must pay the premiums for an insurance that protects the lender.

But the truth is actually otherwise: without mortgage insurance, minimum down payments of 25%-50% would be required of homebuyers with even the most excellent credit records.

Conforming Requirements

The minimum down payment requirements for conforming loans are listed below.  These requirements may occasionally change, but they are the general standards for Fannie Mae and Freddie Mac programs.  Note that condominiums and townhouses are considered single-family homes.

• Fixed-rate loans: Single-family homes—5% to 10% ; Two-unit properties—20%; Three- and four-unit properties—25%
• ARM loans: Single-family homes—10%; Two-unit properties—20%; Three- and four-unit properties—25%
• Balloon loans: Single-family homes—10%; Two-unit properties—20%
• Second homes: Fixed-rate loans—10%; ARMs and balloon loans—20%
• Investment (non-owner occupied) properties: Single-family and 2-unit properties—25%; three- and four-unit properties—25%-30%

If you have very good credit, strong income and ample down payment, you’ll find that conforming loans often offer the best interest rates and loan terms. In many cases, they are also easier to obtain than non-conventional FHA loans.

 

Non-Conventional Loans

Loans guaranteed by either the Federal Housing Administration (FHA) or Veterans Administration (VA) are considered non-conventional loans — and they offer tremendous down payment alternatives for many homebuyers.

FHA loans were introduced during the Great Depression to assist homebuyers who were having difficulty getting financing because of tight mortgage loan underwriting by local banks. In addition to helping revive the housing market, the FHA loan introduced the 30-year fixed-rate loan, which was a new fairly new concept in the U.S. mortgage industry at that time.

The FHA loan’s 30-year fixed-rate mortgage loan gave homebuyers and homeowners more stability and security than the 5-year balloons which were the norm until then. Conforming loans eventually followed FHA’s leads by also introducing long-term fixed-rate mortgage loan.

It’s important to note that the FHA does not really provide the financing for FHA loans. Instead, they entice banks to lend to borrowers with lower income and sometimes slightly lower credit scores by guaranteeing the lender against any significant losses on the loans.

In recent years, FHA loans, in particular have regained widespread popularity — especially because they continue to offer home loans with down payments as low as 3.5%.

Regardless of which route you decide to pursue, make sure that you have all the necessary information and that you seek advice from a professional financial consultant.

Personal Considerations

For those homebuyers with more than adequate cash, the issue of down payment isn’t about minimum levels, but optimum levels.  If you had all the money you needed, how large a down payment should you make?

There is no stock answer for this, except that it depends on the borrower.  For property investors, maintaining strong liquidity (hence paying the minimum down payment) is a primary concern.

For homebuyers, there are many personal issues to ponder.  First of all, down payment affects loan size, which affects monthly payments.  How large of a monthly payment can you carry?  How much do you wish to carry?

Another way that the down payment affects the monthly payment is via the mortgage insurance.  Remember that whenever the borrower makes a down payment of less than 20%, the borrower must pay mortgage insurance.  Moreover, the lower the down payment, the higher the mortgage insurance rate.

For example, the mortgage insurance on a $100,000 loan after a 5% down payment would be approximately $50-$60 per month; with 10% down on the same loan, the mortgage insurance would only be $25-$35 per month.

Consult with your loan officer about the best situation for you, as well as ways to eliminate or minimize mortgage insurance.

Go to next HomeBuyer Guide chapter: “7. Affordability Considerations”