In order to purchase a home, a lender will require your clients to provide a down payment. This is a percentage of the home purchase price that the buyer pays to the seller. However, many buyers have questions about down payments. Here’s what they need to know.
Why Do Mortgage Lenders Require a Down Payment?
Because a down payment consists of the buyers’ own money, it reduces the lenders risk. As Bankrate explains, home buyers have more of an incentive to keep making their mortgage payments because their own capital is tied up in the house. As a result, they’re less likely to default on their loan and go into foreclosure.
How Much Is a Down Payment?
Although most people believe that a down payment has to be 20 percent of the home’s purchase price, this doesn’t always apply. Some lenders will approve down payments of 15 percent or less. However, anything lower than 20 percent will require the buyers to purchase private mortgage insurance (PMI). According to the Consumer Financial Protection Bureau, this is an insurance policy that protects the lender in the event the buyers default on their mortgage payments.
There are instances where a down payment can be much lower. Buyers who have served in the military may qualify for a Veterans Affairs (VA) loan, which is a zero-down loan, or a loan that requires no down payment at all. Buyers who have either a low income, poor credit score or no savings might qualify for a zero-down United States Department of Agriculture (USDA) loan or a Federal Housing Administration (FHA) loan, which only requires a down payment of 3.5 percent.
Can a Down Payment be a Loan?
It’s not advisable for buyers to take out a loan for a down payment. As Realtor.com explains, the reason is that it will impact the buyers’ debt-to-income ratio, which in turn will lower mortgage amount they qualify for. For example, if the buyers have a gross monthly income of $6,000 and a revolving debt of $1,800, then their debt ratio is 30 percent. Now, if they add a loan for a down payment, then their revolving debt could increase to — for example — $2,100, and their debt ratio becomes 35 percent.
Funding Sources for Down Payments
A lot of home buyers use their savings for their down payment. However, there are other funding sources, according to Zillow.
Liquidating assets such as stocks, mutual funds and bonds, as well as 401k or similar retirement funds to fund a down payment is also acceptable, so long as the buyers can produce documentation of the sale and transfer of funds.
In addition, funds that are gifted to the home buyer by parents or other relatives are an acceptable source of funding. The person donating the money will need to sign a gift letter that documents the details of the gift and states that it is not a loan.
It’s important for your clients to understand how down payments work before they start looking for a home. That way, they’ll know what lenders will require of them and have a realistic price range in mind for houses they can afford.