Tuesday, November 18, 2008

How Much Do I Need for a Downpayment?

How much do I need for a downpayment?

It depends.

(Come on, you knew I was going to say that.)

There are some rules of thumb though. First, you can bet you need a heck of a lot more than buyers did a few years ago, or even one year ago. There are lots of influencing factors: type of financing, amount financed, type of home (condo/townhouse/detached house), and whether it’s an investment property or you intend to occupy it.

To understand downpayments, we really need to understand the Private Mortgage Insurance (PMI) industry. These are the guys who ‘insure’ the loan for the bank. If you have less than 20% equity in the property (whether via a downpayment or appreciation), any lender will require you to buy PMI. PMI premiums are paid by the borrower, but the beneficiary is the lender. So in other words, if the borrower defaults, then the PMI policy will pay the lender.

Up until recently, banks would issue a “second trust (mortgage)” rather than requiring the borrower to pay for PMI. So a borrower would have a first mortgage for 80% of the value, then a second mortgage for somewhere between 5% and 20% of the value—so the borrower needed as little as 0%. The mortgage interest on the second trust was deductible (a win for the borrower), there was less downpayment needed (another win for the borrower), and the bank got a second loan at a higher interest rate than the first (a win for the bank, or so they thought at the time, AND they held the home as collateral, which couldn’t possibly fall below the value at which it was purchased, right??) The only people that lost out were the mortgage insurance folks.

Fast forward to the default wave of the last two years. Banks are now holding two bad loans instead of one, and no insurance policy to collect on. PMI folks were just fine with that, as they had their hands full anyway with all of their own defaults. In today’s lending world, you can’t find a bank who’s willing to do a second trust that takes the total loan-to-value (LTV) ratio above 80%. So basically: no second trusts. And it’s really tough to find a PMI firm who will insure a loan without meeting certain conditions.

To really know what downpayment you need, you need to talk to a lender and find a program that works for you. But here are some rules of thumb:

- Conventional loans, count on needing 10 to 20%
- FHA – will require 3.5% (as of 01/01/09)
- VA loans – this is about the only program going where you can still get 100% financing, so if you’re a vet, look into it!
- Investment properties – 30%

There ARE special programs out there, though, like HPAP in the District and VHDA in Virginia. So, again, talk to a lender. I can recommend some great ones. You also need to keep your realtor in the loop. Often certain property types don’t work well with certain loan programs, or may trigger additional downpayment requirements.

If you’re confused about where to start your search and understanding how much you can afford, send me an email. I’m happy to work with you to see what types of homes and program combinations will work best for you.


Jason P. said...

I am confused about whether these percentages you are giving (3.5% for FHA, for instance) would be in addition to paying all closing costs (which can be significant on their own). Can you clarify whether we are able to roll closing costs into any of these loans, or if we would need the full closing costs in addition to the percentages you have mentioned?

Katie Wethman said...

Jason, thanks for your question. Yes, the downpayment is in addition to the closing costs (which run in the neighborhood of 3% in this area). BUT you CAN negotiate for the seller to pay your closing costs as part of your strategy. See my FAQ on the subject at

ive me a ring if you are searching for a home and want to discuss further.

Brandon Green said...

Great explanation Katie! I'm going to link to this entry next week.