The Down Payment

The down payment on a home mortgage is quite possibly the most important hurdle new home buyers have to overcome. First time buyers may feel daunted by the idea of beginning a home mortgage, but there should be nothing to fear. This post is here to guide you through the inner workings of a down payment and describe some of its variations.

In the 1920s, commercial banks and insurance companies typically required at least 50% down, but the more liberal loans and savings associations only required 40% down on a home mortgage. This was all before the Federal Government decided to become a player in the housing market. Since then, down payments have developed their own ranges, such as the VA-guaranteed loans that go all the way to zero down.

Because of the variations throughout its history, a down payment is now defined as the lower sale price and appraised value that is less than the loan amount. A minimum down payment is expressed as a certain ratio to that lower sale price and appraised value. This means the minimum is actually the same concept as a maximum loan-to-value, or more typically referred to as a LTV.

Here’s an example: Let’s say a property is valued at $100,000 and the required down payment is $25,000. That is at a ration of 25% while the LTV is at 75%. Now, there are legal and regulatory requirements that are more often than not specified in terms of a maximum LTV instead of a minimum amount. This is because the LTV is actually less vulnerable to any misunderstandings.

Something new home buyers might not initially realize it that there are different types of sources. The down payment may sound like its own entity when you’re first looking to buy, but there are different variations. Here are some you may not have heard about and may need to avoid or consider:

1. Excess of Appraised Value Over Sale Price: Typically this type is not allowed. Because the down payment is defined as the lower of sale price and appraised value less the loan amount, an appraisal that is higher than the price is usually disregarded.

2. Gift of Equity: This is actually the exception to number 1. This type typically surfaces when someone’s family member is willing to sell their home below the current market value. To calculate the down payment, the appraised value is used instead of the lower sale price. However, this type has a bit of risk. A lender may not be able to accept the equity gift as a complete amount to kick off a mortgage. The lender will then expect the borrower to make some sort of contribution.

3. Home Seller Contributions: Like the first type listed, these are typically not allowed by lenders because contributions will actually be associated with a high sales price. But, home sellers are able to pay their purchasers’ settlement costs. This can allow the purchasers to put more down.

4. Cash Gifts: As long as a cash gift is from a relative, or live-in partner, these types are allowed as down payment funds as long as the source is properly documented. But, a lender has to be aware that the cash gift is not a loan in disguise with some sort of payment obligation. That would reduce the borrower’s ability to begin repaying the mortgage.

Bottom Line of the Down Payment

This shouldn’t be as disconcerting as it’s made out to be. New home buyers should be aware of what exactly they need for a mortgage without feeling overwhelmed. If you’re nervous about signing your first down payment, speak with your lender or real estate agents. You have options, and it’s important that it’s completed properly to get you into your dream home!




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