Saving a 20-percent down payment on a house represents one of the biggest obstacles to homeownership. Fortunately, a first time home buyer can get approved for a mortgage even if he doesn’t have tens of thousands of dollars for the down payment. How is that possible? Besides the fact that the standard 20-percent down payment is just a myth, many lenders are willing to accept less than 20 percent down on a house, a first time home buyer can access a series of low- and no-down payment mortgage programs, including FHA and VA mortgages.
Though a 20-percent down payment isn’t necessary, smaller down payments come with a series of disadvantages, such as:
- Lower Chances of Getting a Mortgage – If a first time home buyer doesn’t qualify for one of the home loans with low or no down payments, getting a conventional mortgage with a down payment of less than 20 percent can be difficult. That’s partly because most lenders consider the 28/36 rule – which defines the maximum debt-to-income ratio a borrower can have to qualify for a mortgage – when analyzing applications. Since the size of the down payment is inversely proportional to the amount of the mortgage and debt-to-income ratio, implicitly, putting less money down means that the home buyer will need to borrow a larger amount. This will result in a higher debt-to-income ratio, which may prevent the applicant from qualifying for a conventional mortgage. As an example, a home buyer who intends to make a 5-percent down payment on a $200,000 home will have to borrow $190,000; with a 20-percent down payment, he will only need $160,000.
- Less Negotiating Power – When calculating interest rates on mortgages, lenders factor in a series of elements, including the credit score, the size of the loan, the amount of the down payment and whether the borrower applies for a fixed- or an adjustable-rate mortgage. A first time home buyer who can’t afford a 20-percent down payment is classified as a high-risk borrower. As a result, he will pay a higher interest rate than a low-risk borrower. If we consider the aforementioned example and compare a 30-year, fixed-rate $160,000 mortgage with a 5-percent interest rate with a $190,000 mortgage with an interest rate of 5.25 percent, the borrower will end up paying $30,000 extra in interest. Besides higher monthly mortgage payments, a higher interest rate means equity kept to a minimum for a long time, which translates into limited options to refinance.
- The Cost of Private Mortgage Insurance (PMI) – Lenders require borrowers to purchase PMI when the equity is less than 20 percent of the home’s value. How much does PMI cost? On a 30-year fixed-rate mortgage for $190,000 with 5 percent down, for instance, the annual PMI premium is around 0.70 percent of the loan amount, based on a Loan-To-Value (LTV) ratio of 95 percent (the LTV ratio is calculated by dividing the loan amount by the property’s value and multiplying the result by 100). That means a monthly PMI premium of about $110. A higher LTV ratio equates to a higher risk profile and a higher mortgage insurance premium. As an example, most lenders increase the annual PMI premium to about 0.90 percent of the loan amount for LTV ratios above 95 percent.
While no one can deny the disadvantages of putting down less than 20 percent on a house, the amount a first time home buyer decides to put down is a matter of personal choice. While some people make a larger down payment to benefit from lower monthly mortgage payments, others prefer to make the minimum down payment required and invest the difference.
Whether you want to find out more about your mortgage options, to discover how to save money as a first time home buyer or to get pre-approved for a mortgage online, we invite you to contact our friendly professionals at North Florida Mortgage.