A down payment is the sum paid to the seller of a house. It’s the initial sum towards home ownership, with the rest of the money paid with a mortgage loan. Generally, down payments are mentioned as percentages. There is a general misconception that mortgage lenders require a 20 percent down payment. Although a 20 percent down payment will result in favorable lending terms such as an elimination of private mortgage insurance (PMI), most lenders require at least a 3 percent down payment.
20 Percent Down Payment is Not Affordable for All
Most homebuyers, especially first time homebuyers, can’t afford to put down 20 percent as down payment for a house. For example, a home purchase price of $250,000, a 20 percent down payment would translate into $50,000, which is quite a hefty sum.
Fortunately, there are several lenders who accept lesser down payment percentages. For at least 3 percent down, a mortgage lender will provide a home loan as long as you meet other lending requirements such as a minimum credit score, steady income, etc.
Drawbacks of a Lower Down Payment
As aforementioned, if you’re putting less than 20 percent of the house’s total price as down payment, you’ll have to put up with some negatives.
Low Equity Risks
A small down payment means you’ll begin your home ownership with a limited amount of equity in the home. You are at risk of being underwater on your mortgage. There is a huge possibility that you will need to come out of pocket if you decide to sell the home a year or two after you purchase it. Adding realtor costs and closing fees, your home might not have enough equity to cover these fees.
Also, if for some reason home values begin to drop, you are immediately at a disadvantage because you don’t have a lot of equity in the home.
Private Mortgage Insurance (PMI)
Buyers making a down payment lesser than 20 percent are require to pay for private mortgage insurance (PMI), which isn’t cheap. A PMI’s sole purpose is to provide protection to the lender in case the borrower defaults. PMI fees vary, based on the down payment size and borrower credit score, ranging from 0.3 percent to 1.5 percent of the loan sum per year.
Higher Closing Costs
Increased closing costs is another expense you need to put up with. As some mortgage closing expenses depend on the mortgage size, minimum down payments would lead to a bigger mortgage sum, resulting in higher closing costs.
Mortgage lenders resort to risk-based price adjustments to arrive at your loan rate. Factors such as the loan type (adjustable or fixed), loan size, credit score, down payment, etc. are considered. A lesser down payment can means higher interest rates, because mortgages offered to buyers who put down a minimum initial amount are considered higher risk buyers compared to the ones who’ve made larger down payments.
To conclude, a mortgage is possible if you do not want to or cannot afford to pay the 20 percent down payment sum. But always remember, there are drawbacks to paying a lesser down payment.