Buying a Home: Down Payment Provides Equity Cushion

How much down payment is enough? The answer depends on factors including home buyers' cash on hand and access to resources that can be used toward a down payment. First-time and moderate income buyers may find the down payment an obstacle to buying a home, but affordable options are available. In general, conventional mortgage lenders require five-to-20 percent down; FHA loan programs allow as little as 3.50 percent down and VA loans can be funded for 100 percent of a home's appraised value. The Wall Street Journal recently reported that some mortgage lenders have eased down payment requirements. Although low down payment requirements are attractive to first-time and moderate income buyers, there are additional risks and costs involved with minimum down payments. While a 20 percent down payment might be out of reach for many home buyers, there are advantages to making as large a down payment as possible

Low Down Payment Poses Risks to Buyers...

Mortgages of more than 80 percent of a home's value typically require borrowers to buy mortgage insurance. Not to be confused with hazard insurance that protects homeowners against casualty losses, mortgage insurance protects mortgage lenders against losses associated with mortgage default and foreclosure. Down payments of less than twenty percent of home value create more risk to the lender and borrower. Real estate markets change and property values move accordingly. Home buyers who make larger down payments enjoy a thicker "cushion" against falling home values. A home buyer who makes a 3.50 percent down payment and whose home declines in value within a few months of purchase could quickly owe more in mortgage debt than the residence is worth. A higher down payment creates more home equity and protection against falling real estate values.

....And Lenders

Mortgage lenders take the position that borrowers without enough "skin in the game" are more likely to default on their mortgages. The Mortgage Bankers Association National Delinquency Survey for the first quarter of 2014 supports this. The seasonally-adjusted national delinquency rate for prime fixed rate mortgages was 3.29 percent, while delinquency rates of 5.49 percent were reported for VA loans and 9.82 percent for FHA loans. Mortgage borrowers with less than a 20 percent down payment can expect to pay for private mortgage insurance on conventional mortgages and FHA mortgage insurance on FHA loans. Borrowers with VA loans don't pay for mortgage insurance, but they do pay a loan funding fee that functions in the same way as a mortgage insurance premium. Annual premiums for private mortgage insurance are pro-rated monthly and added to monthly mortgage payments. FHA mortgage insurance is paid by home buyers in two segments. An upfront mortgage insurance premium is paid at closing or rolled into the FHA mortgage amount, and annual mortgage insurance premiums are pro-rated and added to monthly mortgage payments.

Buying a Home? Down Payment Assistance Sources Can Help

Home buyers can find down payment help through a variety of sources. Down payment assistance options include:

  • Cash gifts from family members: A cash gift requires a letter signed by the donor stating the amount of the gift, the date given and that no repayment is required. The giver must also prove that he or she possesses the funds to give, usually with a bank statement.
  • State and local home buyer assistance programs: Eligibility for down payment assistance received from state housing finance agencies and local community programs may be determined by income and other factors. According to HUD, home buyer assistance and program requirements vary; HUD approved housing counselors can help home buyers find programs suited to their needs.
  • Loans and withdrawals from retirement accounts: MSN Money recommends consulting a financial planner and/or tax pro before withdrawing funds from 401(k) plans or other retirement accounts. In some cases, it may be possible to withdraw funds that can be used toward a home purchase, but the IRS typically charges penalties for early withdrawals from retirement accounts. Employer-based retirement plans may have additional regulations that prohibit or limit early withdrawals. However, borrowing against your 401(k), which is essentially borrowing for yourself, can be a better deal -- as long as you can repay the loan before you leave the job.

FHA, VA Offer Programs for Homes Requiring Renovation, Adaptation

Home improvement shows often feature home buyers finding their "perfect" home only to learn that it needs floor to ceiling renovation. Buying and renovating a home can be costly; it's usually necessary to borrow a construction loan, repair the home and borrow a mortgage after the home has been repaired or renovated. HUD offers a home renovation/purchase loan through its FHA 203(k) program. This loan is based on "as repaired" appraised home value and is available with minimum down payment of 3.50 percent for owner occupied properties. Eligible home buyers can use a HUD 203(k) loan in connection with approved community housing and development programs.

Disabled veterans and their families face challenges when buying a home that isn't accessible to the disabled person. The VA offers grants for eligible veterans and family members to use toward making a home accessible. These grants can be used along with standard VA home purchase or refinance loans to reduce out-of-pocket costs to qualified home buyers/grant recipients.

Real estate professionals and mortgage lenders can help home buyers locate low down payment mortgages and home buyer assistance programs that can help transition home shoppers to homeowners.

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