The Down Payment

Does this sound familiar? Every month you pay a hefty rent check that you know could easily be a mortgage payment. But to buy your own home, you feel you need down payment money and, with all your expenses, you simply haven't been able to save much toward a down payment. Does this mean you won't qualify for a mortgage to purchase a home? Don't count yourself out of the home ownership game yet. You are far from alone, but rather in a vast category of people who have the income to make monthly mortgage payments, but haven't been able to put money away for that elusive down payment on a home.

How much can you put down? First off, let's examine how much you've managed to save toward your dream home. You may be thinking "what savings?" or you may be wondering if you should use your huge nest egg to pay for a house in full or simply as a down payment on the palatial digs you've been coveting. But chances are that, like most of us, you fall somewhere in between these two extremes.

Traditionally, as you may already know, 20 percent of the home's purchase price was the amount people needed to put down in order to qualify for a conventional mortgage, which was usually a 30-year, fixed-payment loan. While many lenders still adhere to that figure, the economic downturn in 2008 changed the rules. The days of freewheeling lenders is gone. So, even if you're required to put only 20 percent down, you will definitely have to establish that you are a very good credit risk to get the mortgage.

Despite the more conservative approach that lenders are taking, mortgages are still available that allow homebuyers to put down anywhere from 10 percent of the purchase price to absolutely nothing at all. Who qualifies for these types of mortgages? Very generally, these types of mortgages are for people who have a steady income and an excellent credit history, but little saved for a down payment. The catch (you knew there had to be a catch) is that mortgages requiring little or no down payment usually carry interest rates higher than traditional mortgages. However, there are mortgages out there that don't require a large down payment, relatively speaking, and do offer competitive interest rates as well. When you are ready to be pre-approved for a mortgage, you can inquire at various financing sources as to whether they offer any special arrangements for lower down payments.

Private mortgage insurance (PMI). There's another serious issue that you'll need to consider if you are thinking about purchasing a home with less than the traditional 20 percent down payment. That issue is private mortgage insurance (PMI). Lenders often require you to carry PMI if you put down less than 20 percent of the purchase price of your home.

Why do lenders require PMI in this situation? From the lenders' point of view, they have a lot more invested in your house than you do if you put down less than that magic 20 percent figure. Due to the high number of mortgage defaults in recent years, lenders are afraid that if you bite off more than you can chew, with little invested in your home, you will walk away and try to cut your losses, letting the home be repossessed. This leaves the lender with an unpaid mortgage and a home they don't want.

How much will this PMI cost you? The cost varies depending on the amount of your down payment and mortgage, but the premiums usually range from 0.25 to 1 percent of the mortgage amount.

If you must go the private mortgage insurance route, how long will you have to pay this extra premium? Again, that really depends on your individual situation. If you got your mortgage before July 29, 1999, you must check the terms of your loan documents. That's because the loan terms govern when or if you can cancel your PMI. If you got your mortgage on or after July 29, 1999, it's a whole different ball game. That's the date Congress stepped in with legislation to fix what had become an unfair situation for many homeowners. It was quite common for many lenders to keep charging homeowners PMI premiums long after the equity in their homes reached 20 percent. For mortgages taken out after July 28, 1999, the general rule is that a lender must automatically cancel the PMI when the homeowner's equity reaches 22 percent.

Maybe you're thinking that PMI is a small price to pay if you don't have enough of a down payment. However, the bad news about PMI doesn't end with its initial cost. Unlike most of the costs associated with buying a home, such as mortgage interest, you can't take a tax deduction for PMI payments. Therefore, we'd like to offer some other solutions if you find yourself coming up a bit short in the down payment department.

You may be able to get your lender to pay your mortgage insurance for you, in exchange for a higher interest rate on your mortgage. Then, since your cost is all mortgage interest, rather than split into your mortgage payment and a PMI payment, you can take a tax deduction for the mortgage interest paid.

If you don't want to pay for PMI you may be able to get two mortgages from your lender. One of the mortgages is for the 80 percent of the purchase price of the home you're buying. The other mortgage is for whatever part of the remaining 20 percent that you don't have down payment money to pay. The down side of this type of arrangement is that the loan for the down payment is usually at a high interest rate.

Example Robert and Kristen, a recently wed couple, went house hunting and found their dream house. They both have high-paying steady jobs, but have managed to save very little in their young lives. The sellers will accept $500,000 for the house, and Robert and Kristen will have no problem making the monthly mortgage payments. Their lender wants a minimum down payment of 20 percent of the home's purchase price, or $100,000, or they will have to pay for PMI. However, all Robert and Kristen can come up with for down payment money is 10 percent of the house's cost, or $50,000, if they sell Robert's sports car. As an alternative, their lender agrees to give Robert and Kristen a mortgage with an interest rate of 7 percent for 80 percent of the cost of the house, or $400,000. Then, after subtracting Robert and Kristen's down payment of $50,000 (10 percent) from the $100,000 (20 percent) needed for the down payment, the lender gives them a second mortgage with an interest rate of 10 percent for the other $50,000 they need for the down payment. Robert and Kristen don't have to get PMI and they should be able to deduct the mortgage interest paid for the two loans. Plus, they figure with their soaring incomes they should be able to pay off the second loan pretty quickly.

If you're in the situation where you will either have to pay PMI or consider these other lending options, you can get information from lenders and PMI companies to determine what's available and which option works best for you.

Tip Don't overlook options that you may have for obtaining down payment money. Some retirement plans allow you to make penalty-free withdrawals in order to purchase a home. While this option isn't for everyone, depending on where you in your age and stage of life, it may be the right one for you. Your employer may also have a program available for loans for home purchases. And don't forget about helpful relatives. Parents and grandparents may be willing and able to make up the difference if you need down payment money to get into a home of your own. If you show them that you are serious about paying them back and set up a payment schedule agreeable to everyone concerned, they will probably be more likely to agree to the loan. If you're lucky, they may not even charge interest, or at least charge you a lot less than your lender. We do want to caution you though, that if you do get a loan from another source for your home down payment, it could affect your ability to obtain a mortgage or lower the amount you're eligible to borrow because you have added another debt to your financial picture.

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