Understanding Down Payment on Mortgage Loan
Why 20 Per cent down payment on mortgage is not a bad idea.
Home purchase is one of the biggest investment you would ever made as it requires a lot of cash outlay. If you want to buy a house, there is likelihood that you will apply for a mortgage loan because of the amount of money you will need to buy the house. Although, people usually save towards the purchase of their home, their savings are not in any case in match with the value of the house they want to buy. That is why mortgage loan is inevitable for many homebuyers. If you want to obtain a mortgage loan, your lender will require that you make a down payment. What is down payment? Down payment is the part of the price of the home that you want to buy which you must pay before the lender can add the remaining balance to make up the purchase price of the house. This amount is usually expressed as a percentage of the price of the house.
Generally, lenders will require that you pay at least 20 per cent of the value of the house as down payment. However, there are exceptions to this rule. You may not pay 20 per cent down payment under the following conditions:
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- When you obtain VA Loans which requires no down payment: This is only available for qualified veterans or their spouse, active duty service members and certain members of National Guard and Reserves. VA Loans are issued by private lenders and guaranteed by the U.S. Department of Veterans Affairs (VA). Therefore, borrowers don’t need to pay mortgage insurance but they will be required to pay funding fee and this will be rolled as part of the loan.
- When you obtain Federal Housing Administration Loan: FHA Loans requires just 3.5 per cent down payment but you will need to pay upfront mortgage insurance premium of 1.75 per cent of the mortgage loan amount.
- When you buy Private Mortgage Insurance (PMI). PMI provides a guarantee that the lender will be paid in case the borrower defaults. With Private Mortgage Insurance (PMI), you can pay as low as 3 per cent down payment. You should understand that Private Mortgage Insurance will increase the cost of your mortgage. However, you may choose to discontinue with the PMI after you have paid up to 80 per cent of the value of the home.
Benefits of down payment on mortgage
As discouraging as down payment on mortgage may look, it comes with some benefits both to the homebuyers and the lenders alike. Let’s first consider its benefits to the lenders:
To Lenders
Less risk: Making up to 20 per cent down payment shows the seriousness on the part of the homeowners. Having put down such amount, there is possibility that the borrower will not want his money to go down the drain. The risk of default is thereby low. The lenders may not need to start running after the borrowers before they get their money back.
To Homebuyers
Lower interest rate: Because of the low risk to the lenders, borrowers stand the chance of enjoying lower interest rate. You know what that means to you. With low interest rate on the mortgage, chunk of your monthly payments will be going towards repaying the principal instead of just servicing the interest on the loan. On the other hand, savings on the interest can be used for other important purposes.
Lower monthly payment: Having paid 20 per cent of the home’s value, the average amount you will need to pay back monthly will reduce. For instance, if the home’s value is $240,000, you would have paid $48,000 representing 20 per cent as down payment. Going by just a simple calculation without taking interest or any other costs into consideration, you will only need to pay back $192,000 as principal as against $240,000. This will also reflect in your monthly repayment amount.
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More home equity: Right from the day you make your down payment, you start building your equity on the house. This is another line of financial security for you. You can easily borrow against your home equity. Home equity loan is easier to get than other types of loans as you will be borrowing against the equity value of the house. That is, your home will serve as security. For this reason, you can also enjoy low interest rate on the home equity loan. But home equity loan is not without its ricks. You can lose your home to the lender if you fail to repay the debt.
No need for mortgage insurance: If you can afford to make 20 per cent down payment on your mortgage, there won’t be any need for you to pay for mortgage insurance. Mortgage insurance becomes necessary when a borrower pays below 20 per cent as down payment. The mortgage insurance provides a security for the lender in the event of default on the part of the borrower.