Down Payment, Mortgage Insurance & Cash Reserves

Use Your Money Wisely When Making a Down-Payment

When you are buying a home, the size of your down-payment is a very important factor. Of course, it is not the only important factor. Your credit rating, credit history, and debt-to-income ratio are also crucial.

What is Down Payment?

A down-payment is the total amount of cash you put down towards your home purchase. Before the mortgage meltdown, a few years ago, there were financing options that allowed even borrowers with less than excellent credit to finance a home purchase with 0% down, sometimes even without proof of their income. Now, the days of 0% down for a conventional loan are gone.

Amount of Cash You Need

Your down-payment is not the only expenses you need to account for, when you want to buy a home. You also need to have cash available to cover:

• The loan fees that your lender charges (origination fees and discount points)
• The third party fees you'll pay (appraisals, title fees, escrow charges, etc.)
• Pre-paid costs for property taxes and homeowner's insurance
• Any minimum reserve requirements your lender requires

Don't assume that all the money that you've saved up is money you can use for a down-payment. For example, if you want to buy a home and have saved up $20,000 to buy one, you have to account for the costs listed above, so you figure out the right way to use your cash to get the best loan type, interest rate, and financing terms.

How much money you have to put towards your down-payment will affect:

1. The type of the loan you get
2. The total amount you can borrow
3. Whether you have to pay for mortgage insurance

Down-payment, LTV & Loan Programs

Your eligibility for different loan programs is dependent on how your down-payment affects your loan-to-value (LTV). Your down-payment is the amount of money you put into purchasing the property. For most borrowers, the down-payment represents the difference between the purchase price and the loan. However, your down-payment is not the only factor used in determining your LTV.

Your LTV is based on:

• Total Loan Size: Your total loan amount needed to purchase the property and pay for any closing costs that you roll into the loan
• Home Value: The lower amount between the purchase price and the appraised value is used to determine your LTV.

Down-payment and LTV requirements differ from loan program and can also vary from lender to lender. Here are some of the main points to consider:

1. VA Loans: VA loans have the lowest down-payment requirements. If you are eligible for a VA loan, you can buy a home with 0% down.
2. FHA Loans: FHA loans offer the next lowest down-payment options. You can get an FHA loan with a down-payment as low as 3.5% and can roll-in closing costs without it affecting your LTV. FHA loans also are attractive as they have less strict credit requirements than conventional loans
3. Conventional Loans: Most conventional loans require at least a 10% down-payment. For a conventional loan, if you roll your closing costs into the loan, it will raise your LTV. One reason to take out a conventional loan is to avoid the need for paying for mortgage insurance, but that requires you to make a down-payment of at least 20%, including the closing costs, if you include them in your loan.

Mortgage Insurance & Down-Payment

If you don't have 20% to put down on the your purchase mortgage loan, you're going to have to pay for mortgage insurance. While it is a good goal to aim for buying a home with 20% down, it is not always realistic. The only way that you may qualify for a home loan is in a loan program that requires mortgage insurance.

Mortgage insurance can add a significant cost to your loan's monthly payment. Not only that, your costs for mortgage insurance are included in your debt-to-income ratio. Therefore, if you have to pay for mortgage insurance, it will affect how expensive a home you can buy.

If your purchase mortgage requires mortgage insurance, make sure you know how much you have to pay and for how long. For instance, there is a big difference between the mortgage insurance requirements of an FHA loan and a conventional loan. FHA loans require both an up-front mortgage insurance payment (UFMIP) and an annual mortgage insurance (which you pay monthly). There is no up-front mortgage insurance for a conventional loan. The current FHA UFMIP is 1.75% of your loan total. If you have a $200,000, your UFMIP would be $3,500. UFMIP can be rolled into your loan.

Cash Reserves & Down-Payment

Your lender may require you to have a certain amount of cash in reserve, in order for you to qualify for the loan. A cash reserve requirement protects the lender, reducing its risk. Your cash reserves would be used, if necessary, in case of some kind of emergency.

Cash reserve requirements depend on your credit score, LTV, and DTI. In some cases, you may need enough reserves to cover your mortgage payment for six months. Some low-risk borrowers are not required to have a cash reserve at all.

Using Your Cash to Your Advantage

Buying a home and making a down-payment requires a lot of planning. You need to allocate your cash effectively. If you have a fund to use to buy your house, don't assume that you can use it all for a down-payment.

Start by speaking with a loan officer, to find out what kind of loan that you qualify for. See what kind of down-payment that loan requires, determine if you will need to pay for mortgage insurance, and whether or not you'll be required to have cash reserves on hand.