Mortgage Down Payments

Sources of Mortgage Down Payments

A mortgage lender requires a down payment simply to ensure that you have enough of a financial stake in the property you are buying that you will not walk away from it at the first sign of trouble.

Usually the minimum mortgage down payment is 20%. Below that lender usually requires you to purchase Private Mortgage Insurance (PMI). With PMI the insurance company will pay the down payment if you default, making the lender more comfortable with granting the loan. ( Read PMI for information about mortgage insurance.)

You can also get around a mortgage down payment with a so-called 20-80 mortgage or, if you qualify, by buying using certain government guarantee programs.

A 20-80 mortgage (the numbers reflect how much each mortgage contributes to the full purchase price and will be reduced by any mortgage down payment you do make, for example 10-10-80) is a tool to get around PMI. You can have 100% financing if you like. This only makes sense if the combined mortgage payments are less than a 80% mortgage plus PMI.

Low income people can qualify for a low or no down payment mortgage guaranteed by the FHA. There may be other forms of mortgage down payment assistance as well. Contact you local city hall.

Lenders know of these plans and can get you into them. Make sure that they are not misrepresenting your financial condition to the government and that they are not adding on excessive fees, which will be made part of the mortgage principal.

Most people borrow using conventional mortgages. In that case, the lender wants to know how much you can put down and, in many cases, the source of the funds.

How much you can put down will determine in most cases how much they will lend.

The more money you put down, the greater the chances you will get the loan at more favorable terms. The reason for this is simple.

A house can be appraised at $100,000. All that means is that comparable houses in your neighborhood have been worth about that.

But in reality, it’s anybody’s guess what the house will actually sell for, especially in distressed circumstances, for example at a foreclosure auction.

If the bank had lent you $80,000 on the house, it might be lucky to get $40,000 at a foreclosure sale. In many cases, it might get a lot less.

However, if the bank only lent you $50,000, then the loss would be a little more palatable. So, in effect, the higher mortgage down payment provides the lender with greater protection against risk of loss.

Source of Funds for Mortgage Down Payments

Preferably the source of your mortgage down payment should be your personal savings and investments. Most current homeowners use the sales proceeds from their current home to cover the down payment on a new one.

Be prepared to document any investments, such as stocks, bonds or mutual funds that will be used towards the mortgage down payment.

However, most first time home buyers don’t have enough savings in hand to come up with at least 20% for a down payment.

If you want a home, but don’t have enough money saved, you can certainly take advantage of PMI. It’s relatively expensive, but you only have to keep up the premiums until you build up 20% equity in your home.

If your house continues to appreciate and you get your hands on some extra money, say a bonus, you might be free of PMI rather quickly.

A common source of funds for a mortgage down payment is a gift or loan from relatives. If you had nothing in the bank and suddenly $20,000 appears, the bank might question its origin.

If it’s a gift, you might be required to have the donor sign a “gift letter” swearing they are actually giving you the money with no strings attached.

If it’s a loan, legalize it with a promissory note which you can present to the bank if asked. This can be converted into a second mortgage later, if necessary.

If you have money in a conventional IRA, you are allowed to withdraw, penalty-free, up to $10,000 of your funds ($20,000 if married) towards a “first time” house purchase. This doesn’t really have to be your first house: as long as you did not own a principle residence for at least two years before the purchase, you qualify for this break.

Since you have to use the money for a house purchase within 120 days of withdrawal, timing is critical.

If you have a Roth IRA, the rules are different. You can make the same withdrawals, but the money must have been in your Roth account for at least 5 years.

Similarly, you can withdraw funds, penalty-free, but not tax-free, from your 401K plan to buy a primary residence.

Whether it is prudent to withdraw retirement funds for a home purchase is a difficult question to answer. It depends on the growth of your tax sheltered investments against the hopeful appreciation of your home.

It is true that your home might appreciate faster and higher than your IRA’s or 401K’s may grow. But that is far from a certainty.

You are able to borrow to buy a house. You are not able to borrow to finance your retirement. It might be best to leave your retirement funds alone.

If you have doubts about this consult a Certified Financial Planner or CPA. (Read financial planners to learn more about them.)

A safer course would be to borrow against your 401K plan. The interest you repay on the loan is credited to you. Of course, you would lose some tax free growth until the loan is repaid. And the bank will consider the loan repayment in determining how much to lend you. There are tax consequences if you are laid off before the loan is repaid.

Since lenders offer so many different mortgage packages, if you’re short on the mortgage down payment, shop around and see what your options are. You might be find a lender who will make the cost of a low-down payment mortgage attractive enough so that you are not tempted to touch your retirement funds at all.

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