What is the Down Payment?
The term "down payment" is used in the context of buying large expensive items like cars and houses, whereby a loan is required to make the full payment. The down payment is the initial upfront portion of the payment, usually given in cash. The main purpose of a down payment is to ensure that the lending institution can easily recover the amount of the loan in the event that the borrower goes into default.
Typically, a loan involving a down payment is obtained for the purpose of purchasing some sizable asset such as a home or a car. The asset in question is then used as collateral in order to secure the loan against default. If the borrower fails to repay the loan, the lender is legally entitled to sell the asset and retain a portion of the proceeds sufficient to cover the original amount of the loan. By requiring a down payment in advance, the lender greatly increases the chance that any such future sale would be able to cover the full amount of the loan, because such a sale only requires the lender to recover the difference between the original selling price and the amount of the down payment, as opposed to the entirety of the original selling price. If you've got the money, there are advantages to putting 20% down. For one thing, you immediately have substantial equity in your home. This may be important to you psychologically, and that counts.
In addition, you'll avoid having to pay private mortgage insurance. Various incentive programs and more complex lending solutions, which may bring the down payment needed down to nothing, now exist for first-time buyers and veteran buyers alike. The 80-20 loan arrangement is one which has become relatively popular, in which the first 80% of the loan is taken out as a first mortgage, and the remaining 20% is taken out as a second mortgage, leaving the buyer with no down payment commitment, simply less beneficial terms than they might otherwise have. Interest-only loans are another path which may allow a buyer to pay a substantially smaller down payment than 20% -- often as low as 3-6% of the total cost.
Zero Down Payment Vs Low Down Payment Options?
Zero down doesn't mean free there are costs associated with this type of mortgage. What it does mean is that you do not need a down payment to purchase a home. In the past 5% to 10% of the purchase price was needed prior to qualifying for a mortgage. This traditional financing still exists but the zero down option provides quicker access to home ownership.
Owning a home is part of the American dream. And, it's proven to be an excellent long-term investment, as well. With mortgage interest rates at historic lows, anyone who is paying rent can probably afford to buy their own home or condominium. Some prospective buyers still think they need a big down payment of 20 or 25 percent. But that's not true anymore. Let's look at some of the ways to buy a home with a low down payment mortgage. VA offers no-down-payment home loans to qualified veterans. FHA requires only a three to 5 percent down payment. Fannie Mae offers its Flex 97 plan with only 3 percent down, but you will need good income and excellent credit. PMI (private mortgage insurance) on home loans with less than 20 percent down will add to your monthly payment.
Because no down payment mortgages are riskier than mortgages secured by down payments, lenders are judicious in qualifying applicants. Estimating only one in four applicants are approved because the underwriting guidelines are more stringent. The lenders scrutinize the appraisal, the income and the credit history. As a result, lenders agree they get more inquiries about zero-down mortgages than applications. Zero down mortgages generally require buyers to pay an interest rate premium of about one-fourth of a percentage point to more than a percentage point over traditional mortgage products. And since private mortgage insurance companies charge higher premiums with lower down payments, 100 percent loans have higher private mortgage insurance costs, too.
There are, however, still significant advantages to making a down payment. First, you're almost certain to get a better rate that will save you thousands over the life of the mortgage. Second, you attain instant equity in your new home, and can borrow against that equity, meaning you really get to use that down payment money twice!