Mortgage 101: The Connection Between Your Mortgage and Down Payment
Getting a Mortgage Used to Be Harder
Not too long ago, getting a mortgage was easier said than done. In the wake of the financial crisis, banks tightened up their purse strings to such a degree that it seemed the only people who could qualify for a home loan were those who were wealthy enough not to need one in the first place. Times have changed, though, and as the economy has gradually recovered mortgage lenders have again turned on the home loan spigot. The 20% down payment, once the bar for entry into homeownership, is no longer a requirement. In fact, it’s possible to qualify for a mortgage with as little as 3.5% down, and in some cases, even zero down.
We’ve established that you can become a homeowner with a very small down payment, but the question remains: should you? Well, that depends on your situation. If you are considering purchasing a home with a small down payment or none at all, there are some important factors to weigh when making your decision. So what exactly is the connection between your down payment and your mortgage?
When It Comes to Mortgages, Money Talks
One of the chief advantages of putting down a substantial down payment is that it gives you more leverage in the negotiating process. The very fact that you’ve been able to save up tens of thousands of dollars is a strong indication that you’re reasonably successful, fiscally responsible, and serious about owning your own home. Because you’ll have more “skin in the game” than a borrower with a smaller down payment, lenders know that you’re statistically much less likely to default on your financial obligations. And even if you do default, your lender will be better able to recoup its losses, because the loan-to-value ratio will be lower on your mortgage than on a loan made to a borrower with a smaller down payment. That makes you a low-risk borrower. Lending to you is less of a gamble than granting a mortgage to someone with little to lose, so banks will typically be more willing to negotiate lower interest rates and more flexible terms. They may also be more amenable to waiving origination fees and other typical closing cost add-ons.
The bottom line is this: if you have good credit, gainful employment, and a hefty down payment, then you’re an ideal mortgage borrower, and lenders would rather you borrow from them than from their competitors. So, they may be willing to “play ball” to snag your business. In contrast, those who don’t have the cash for a down payment will basically have to play by the lender’s rules if they want to qualify for a mortgage.
Down Payment and Private Mortgage Insurance
Private Mortgage Insurance, or PMI, is a type of insurance intended to protect the lender against the losses they might incur, should a borrower default on a mortgage. If you’re putting down less than 20% on your home, then you’ll be required to pay for PMI. The premiums on PMI typically range from 0.5 and 1% of the total loan value per year, and are included in the monthly mortgage payment. Half a percentage point might not sound like much, but it definitely adds up over the years. Conventional mortgage borrowers can look forward to PMI premiums automatically falling off of their monthly payments once their mortgage’s loan-to-value (LTV) ratio reaches 78%, or 80% if they contact the lender directly. At that point, they’ll have 20% equity in their homes, which moves them into a lower risk category, just like those who put down 20% when the mortgage is originated. However, FHA loans, which are a popular option for those without a substantial down payment, require mortgage insurance throughout the life of the loan. These loan programs make homeownership affordable for those who might not otherwise be able to qualify, but there is a cost.
The More You Can Put Down, the Better Off You’ll Be
It’s clear that having a substantial down payment has definite advantages, but for many borrowers, it’s not always possible to stash away the extra money. Still, even if you can’t save up the gold standard 20%, you’d be well advised to put away as much cash as you can before applying for your next mortgage.