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Higher Down Payment Dollars Lead to Lower Rates and Better Terms - 2007-12-01 |
By now we've all heard about the subprime mortgage crisis and its impact on buyers at all levels. And there's no question that stricter guidelines and tighter underwriting standards have taken a toll, especially on first-time buyers.
But there's another side to this story that most of us haven't heard about. It's the impact of downpayment size on interest rates and terms.
While we as buyers think in terms of downpayment dollars, lenders look at it from the other side of the transaction. What percentage of the sales price is the borrower seeking to borrow? That number is called the "loan to value" ratio, or LTV for short.
In recent years, the average LTV crept higher and higher, especially for first time buyers. As a result, the vast majority of the homes in foreclosure today were at or near 100 percent LTV homes. In other words, the borrower made no cash down payment whatsoever.
Well, times have changed, and lenders have realized that there is a direct relationship between how much cash a buyer invests in his purchase and the likelihood that the buyer will make his loan payments on time all the way through to payoff. Stated more succinctly, the larger the cash downpayment, the lower the risk to the lender.
Now that we have lived through the sub-prime crisis, more and more lenders are recognizing that a larger down payment is desirable, and they are rewarding larger down payments with faster approvals and better rates. So I thought it would be a good idea to review what forms of assets are acceptable as a downpayment and what sources are considered a no-no.
The first thing you need to know is that your lender will look very closely at the source of your downpayment. And the less you have to put down, the more carefully the source will be scrutinized. In short, the money has to be yours, it cannot be borrowed, and you have to be able to explain where it came from.
Here is a list of acceptable sources for downpayment funds, roughly in order of how much an underwriter would like to see them:
* Savings accounts are the best, because they indicate that you have been able to discipline yourself financially and set aside some of your income rather than spending it all and more each month. The lender will want to see at least three months worth of statements showing where the funds came from.
* Checking accounts are also verifiable and traceable, so lenders like to see that you have some extra funds to spread around. They want to see that your paycheck is coming into the account regularly, and that you are living within your means. Three months of statements will do that, and provide a good source for your downpayment.
* Brokerage accounts are just as good a source as checking and savings accounts, and can easily be traced as to source. Stocks, bonds, and mutual funds all have a current value. If you are willing to sell, that amount is an acceptable source of your downpayment dollars. Beware of stock in non-publicly traded entities, such as your family limited partnership or your multi-member LLC that owns a rental property.
These may be much harder to pin an actual value on, and the lender may balk at these sources unless they are converted to cash.
* Balances that you have in retirement accounts such as IRAs or 401k programs are typically acceptable as a source of home downpayment funds, although you may wish to think twice before tapping into retirement dollars. In most cases, I prefer to leave retirement funds alone and find other sources for your home purchase.
And even though your 401k may have a feature allowing you to borrow against it to purchase your first (or next) home, be aware that home lenders consider any form of borrowing for a downpayment to be unacceptable. Even though the money is yours in the first place, the borrowing adds to your monthly debt ratio, and in their view, adds to their risk.
* Cash value of any whole life insurance policies you may own is another source that can be utilized for a downpayment, especially if your financial plan can replace the coverage another way or you no longer need the coverage.
* Equity that you have in other real estate is an acceptable source of funds, although the transaction costs of real estate sales and the time necessary to obtain the proceeds may deter your plan. Tapping into a line of credit on that same property, however, is considered borrowing your downpayment, and would likely be frowned upon.
* Proceeds from the sale of any assets you may already own are fine. So what about that old silver dollar collection, or your paid-for houseboat. For that matter why not have a garage sale next weekend and clean out the attic at the same time. Dollars from the sale of your assets are perfectly acceptable as downpayment funds.
* Funds from your co-borrower are also fine. If you and a roommate decide to buy a house or condo together, the lender doesn't care which of you comes up with the downpayment, since there will only be one loan on the total property. So if your roomie has a trunk full of savings and you have none, you can team up to get the best deal on a loan.
Also know this: regardless of your arrangement with your new real estate partner, each of you is fully and personally responsible for the entire debt, until the day when it is finally paid off.
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