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.

PMI Risk Index: 80% Chance of Rising Prices in Next Two Years

PMI Mortgage Insurance Co released its latest U.S. Market Risk Index, which ranks likelihood of declining prices for the nation’s 50 largest metropolitan statistical areas (MSAs). PMI Mortgage Insurance Co is one of the largest providers of PMI in the US, so you better believe they spend a good chunk of time studying the market, prices, and defaults.
The bad news is that the decline in national prices accelerated in the first quarter of 2008. The more interesting news for our area is that the Washington-Arlington-Alexandria MSA had a risk rank of just 3 (of 5) and risk index score of 21.4, down from 29.1 last year.

This risk index reflects the probability that prices will be lower in two years. So if you're planning on waiting to buy because you think prices will drop, this report is estimating that there is a 1 in 5 chance that you will make out better if you wait two years; said another way, there is a 4 in 5 chance that prices will go up. This is no doubt tied to our area's continuing low unemployment rate of 3.6%, the lowest of all 50 MSAs.

Buyers: 80% chance prices will go up...you might want to start your search soon.

Sellers: Hold on a little longer...your odds are improving.

Read the full PMI report report here.

Short Sales: Are They Worth a Buyer's Time?

Yes. No. Maybe. If you’re looking for an absolute, don’t bother reading this post. I’ll go out on a limb and say usually it’s a waste of a buyer’s time—the odds are certainly against it.

What is a short sale? It’s a sale where the debt owed combined with the costs associated with the sale exceed the property’s market value. Creditor(s) MAY be willing to agree to allow the property to be sold for less than the loan amount.

You can recognize these listings by key phrases in the comments section such as “short sale” or “third party approval required” or “lender approval required.”

As a seller, how do I go about a short sale?
Every bank is different. At a minimum, you will need to establish that you are financially incapable of paying the loan(s). You must submit W-2s, bank statements, tax returns, a “hardship letter” stating the reason the credit should consider granting a short sale, and other financial statements outlining your assets and liabilities. The hardship letter is particularly important. Stating that your house isn’t worth what you paid for it is NOT a hardship. You must establish why you are no longer able to afford the payments.

As a buyer, I keep hearing that Short Sales don’t close. Why not? Can I do anything about it?
Some close, but it’s true that most do not. A quick search of the local listings showed 282 active short sales. In the past 90 days, only 35 closed. That’s a very poor hit rate. Short sales are typically priced at or just below current market value, and that’s reflected in the close price of those 35 homes—average closed price was $367K versus an average list price of $373K—98% of asking!

The overwhelming majority of short sales don’t sell and/or close because of one of these reasons:
(1) They aren’t priced competitively so don’t get any offers. On the flip side, sometimes they are priced at a low price that the bank will never accept!
(2) The sellers have not met the lender’s requirements to approve a short sale (e.g., have not submitted a hardship letter or otherwise proven that they can no longer afford the payments
(3) A secondary or tertiary lien holder has not approved the sale (if the first lienholder isn’t getting paid in full, the guys behind him are making nothing, and so have zero incentive to sign off on a deal). Often in this situation they will ask for a personal Promissory Note from the seller. If the seller refuses, it will scuttle the entire deal.
(4) The lender has received all of the paperwork but is “stringing along” the seller to collect a few more payments
(5) The lender has received all of the paperwork but is planning on foreclosing and collecting the mortgage insurance.


Buyers have no control over any of these reasons. Sellers have limited control over some. But it only takes one of these to prevent a short sale, so the odds are against it. In particular, if the bank is bound and determined not to approve a short sale (reasons 4 and 5), then no one can make them. If a seller is determined that they do not want to attempt to repay any of their debts (reason 3) then it’s not going to happen. Reasons 1 and 2 have a much better chance of closing. But why would a homeowner and agent list a home when it’s either overpriced or when the paperwork isn’t in? Lots of reasons: naiveté, ignorance of or inexperience with the process, denial. Why would an agent waste their time with a listing that won't sell? In most cases, there’s no real ‘cost’ to them. Agents decide individually how they want to market properties and how much they'll spend doing so. So they choose to spend nothing, and infact, they still get some free advertising via the yard sign and mere existence of the listing.

How can buyers identify a short sale that is more likely to close? Agents can put basically anything they want in the comments, but a few key phrases give you slightly better odds:

• Bank already approved price of $x/Short sale already approved
• Only one lien
• No waiting/bank ready to close/can be closed immediately
  
• Paperwork already submitted
• Quick Response/Turnaround in x hours/days/weeks
  

And of couse, you should have your buyer agent contact the listing agent to see what the status of the paperwork is. If the agent doesn't know or doesn't return the call, it's likely to be a waste of your time as a buyer.

Buyers, remember that, just like with foreclosures, timing is a big issue and so taking your chances with a short sale isn’t for everyone. With every passing week, banks are getting more efficient at processing these, so we might see more short sales and foreclosures closing. There’s also speculation that banks have too much real estate owned (REO) on their balance sheets, which impacts their regulatory capital requirements; so they may very soon be more amenable to short sales in the months to come.

Read More: Foreclosure Risk Series

Read More: Understanding the Difference Between Short Sales, Foreclosure Auctions, and Bank Owned Properties (aka REO)

Out: Exotic Loans, 100% financing; In: FHA, VHDA!

FHA is back with a vengeance. It's a key tool in the current lending environment for getting buyers qualified with only a 3% down payment (with gifts permitted in certain circumstances.) There are a few extra hoops to jump through, but I find more and more buyers are utilizing FHA now that the lending limits have been increased in our area.

The Virginia Association of REALTORS has this webcast "Mortgage Lending in 2008: Back to the Future, How FHA can help you and your clients," for agents, but I think it provides a good overview of FHA for anyone thinking of buying. At about an hour, it's a bit long, but worth it.

Some Restrictions on Condos
FHA won't work in some instances, though. Sometimes condos--especially new construction--gets tough. Condos must be on the FHA-approved list to qualify. If it's not on the list, it's still possible to get a spot-approval, but it must meet certain other criteria, e.g., more than 60% owner-occupied, which sometimes is problematic with condos. Some of the criteria may be streamlined as part of an expected upcoming FHA modernization, though, so stay tuned.

VHDA Loans
Another great option for first time buyers in our area are programs through VHDA (Virginia Housing Development Authority), which provides a variety of low-interest loan programs and low-down payment options for buyers who meet certain maximum income limits and property price restrictions. You also must not have owned a home in the previous 3 years unless you're buying in a designated target area, must attend a VHDA-approved educational seminar, and meet certain other guidelines.

Read more: Mortgage Loans: Jumbo, Conforming, FHA, and Jumbo Lights

Read more: Why Don't Fed Cuts Always Cause a Drop in Mortgage Rates?

Read more: What is Private Mortgage Insurance (PMI)?

Want to learn more or have more questions? Attend a free first time home buyer seminar that I teach.

FAQ: Mortgage Loans - Conforming, Jumbos, FHA, Jumbo Lights

Although I’m not a mortgage broker or lender, I get a lot of questions from my clients and in my first time homebuyer classes about interest rates, points, and fees. There’s a lot of confusion out there right now about what the conforming limits are, how FHA works, and what the stimulus package impact will be. The short answer is that we don’t have all the answers yet—the mortgage market changes by the minute. I always recommend to my clients that they choose a lender they trust and then stick with him/her (I’m happy to make a recommendation or two if you contact me.) An online mortgage calculator will never keep up with the pace of change and options (both coming and going) in today’s market. In my opinion they are nearly worthless if you're seriously thinking of buying a home (though if someone has found a good one, by all means, let me know!)

Here are some of the basics, including some basic economics on risk and reward (I admit these are over simplified, but I think will suffice to give buyers an idea.) You have to think of your mortgage as an investment product. Somewhere out there is an individual investor with a million dollars to invest; He can invest in the stock market, in gold, in CDs, are in mortgages, for example. The higher the risk he takes with his money, the more reward he will expect. These are some of the “flavors” of mortgages and rates:

• “Conforming” Loans. Until recently this meant ONLY loans less than $417,000 that met Fannie and Freddie underwriting guidelines. Fannie and Freddie are government sponsored entities that purchase loans from banks, package them up, and sell them off. Because the bank has a “guaranteed” buyer for your loan, it lowers their risk and hence lowers the interest rate (low risk for a bank = low reward for a bank.) Fannie and Freddie also slap their own guarantee on these products, so the people they sell them to are willing to earn a lower return because there is less risk. These loans have the most competitive rates. All Fannie and Freddie loans are subject to their underwriting guidelines, including their downpayment restrictions. Because both entities have slapped a "declining market" label on our area, downpayment requirements are higher now than they were a year ago to the tune of 5%. So if previously you were the quality of borrower that could have qualified for a 95% loan-to-value (that is 5% downpayment), this new label means that you now only get 90% (a 10% downpayment) if you want a Fannie- or Freddie- backed loan.
  
• “Jumbo” Loans. Loans that are above $417,000. They carry a higher rate because Fannie and Freddie are prohibited from buying them, and hence the risk to your bank is higher—they need to find a buyer out there, or they need to keep it in-house.
• “Jumbo light” or “jumbo conforming” Mortgages. These are new in 2008 as a result of the stimulus package. Fannie and Freddie are temporarily allowed to buy loans up to 125% of the median purchase price of an area. For the Washington, DC, area, that means $729,950. So this new layer represents a loan that meets Fannie and Freddie’s guidelines and is between $417K and $729,950. Rates on these loans are still in flux, but chances are that it will be somewhere between “conforming” and “jumbo.” Fannie and Freddie put some limitations on which ones they will buy though, so expect some hoops: at least 10% down, or 20% if your FICO score is less than 700, among others; Below 660 and you’re out of luck altogether. One thing the market (our individual investor out there) doesn’t like about this new layer is that it’s temporary, so he’s not sure what will happen to it in the future. Investors don’t like uncertainty, so even though there’s a theoretical “buyer” out there in Fannie and Freddie, he nonetheless wants a premium for it in the term of a higher rate of return.
• FHA Loans. Once the stepchild of the mortgage industry, it’s quickly coming back in favor because of its low down-payment (3%) requirement. FHA loans are guaranteed by the government, so risk to an investor is low. Low risk = low reward, or in other words, lower rates charged to borrowers. FHA until recently had a very low limit, so was not widely used in this area. But Congress recently approved an upper limit of $729,950 in our area (same as the “jumbo lights”). Similar to that scenario, rates on that mid-tier (between the old limit of $362K and the new limit of $729K) will likely carry a small premium over “regular” FHA loans below $362K. FHA comes with its own set of hoops to jump through; for example condos must be on the FHA approved list.

Again, I highly recommend speaking to a mortgage professional if you’re not sure which product is right for you – they all have advantages and disadvantages, and programs and guidelines are changing daily. In a future post I’ll try to touch more on FHA loans, the Nehemiah program (a roundabout way for a seller to “gift” your downpayment!), and the rates/points/fees tradeoffs (the best rate isn’t always the right answer!)

If you’re interested in learning more, I encourage you to attend my first time home buyer class. Details are here, and you can email me to register.

Are you ready to begin your home search? I’d be happy to speak with you about some of the advantages and disadvantages of loan programs and how they impact your negotiating ability in a transaction. Just drop me an email or call and we’ll set up some time to talk about your search.

Read more: Why Don't Fed Cuts Always Cause a Drop in Mortgage Rates?

Read more: What is Private Mortgage Insurance (PMI)?

Want to learn more or have more questions? Attend a free first time home buyer seminar that I teach.

Interest Rate Jumps; Unfortunate, but not Catastrophic

I'll be writing on this quite a bit, and I'll start off by saying that, as regular readers know, I do NOT think recent interest rate jumps are the end of the world. I'll get to why in a bit, but first, a recap.

Last week, large mortgage lender American Home Mortgage shut its doors. That made the markets very panicky and led to an increase in rates for two specific loan types: "Jumbo" and 2nd trusts.

"Jumbo" loans are loans above $417,000--the limit for "conventional" loans set by Fannie and Freddie, who buy mortgage loans from originators. Fannie and Freddie exist to create a “secondary market” for mortgages—that is, they buy loans for cash, and then originators use that cash to make more loans to homebuyers. If they didn’t exist, then banks would only be able to loan as much cash as they had on hand, and would have to hold the mortgages until each homebuyer sold or paid it off. (That’s a bit of an over-simplification, but for our purposes it should suffice.) Fannie and Freddie are government “sponsored” (though not technically government-insured), and so the loans they can buy have certain restrictions, i.e., are under $417K. Because there’s an easily available secondary market for this size loans, they typically have a lower interest rate than the larger, or “jumbo” loans.

Now, $417K doesn’t buy you much in this area, so lots of people end up with “jumbo” loans. And since even the smallest place is usually in the $300s, many people in this area don’t put 20% (or about $60K+) down. That hasn’t been an issue until now. You can put 5% down, take out two “trusts” (or loans)—one for 80% and one for 15%, and be on with your home purchase. Those second trusts are becoming an issue, though. Read on:

The second impact of this panic is a big jump on the 2nd trust rates. 2nd trusts have always been riskier for lenders—they’re junior liens, after all, and so carried a higher interest rate. But that rate is the other important change in the past week. It jumped significantly.

Two impacts on this market are clear, but in my opinion, neither is catastrophic. At least not yet.

1) For most buyers, they can afford less. So if you were shopping at the top of your affordability range, chances are you can no longer afford that payment, regardless of how much you were putting as a down-payment. How much less? We’ll have to see where the rates stop. According to the Post, rates are up almost a full percentage point since May. So for every $10,000 borrowed, that’s $100/year.

Let’s use an example. Let’s say a buyer was looking at in the $600,000 range starting in May. Rates jumped up a point since then. That means that if there is NO room in their monthly budget (and why would any responsible person be looking at that price if there was absolutely no room in their budget?!) then now they can only afford $500,000. Another way to say it is that having the same $600,000 mortgage now costs them an extra $6000/year (which, making some assumptions about income bracket, is about $4000/year out of pocket after taxes.)

My guess—and I certainly could be wrong—is that people shopping for $600,000 homes have just a little bit of wiggle room in their budgets, maybe even up to $4,000/year. I think most people in that income and affordability bracket will make the trade-off, see their home as an important investment, and forgo a few discretionary items to get the house that they still want. I believe that the majority of the people are NOT going to change the range in which they’re looking, at least not by much. Again, maybe I'm naive, or maybe I'm just lucky that my clients tend to be responsible purchasers (or, not to pat myself on the back too much, but maybe I do a good job counseling them up front and introducing them to reputable lenders who counsel them too).

In my experience, the people who tend to stretch their budgets to the breaking point are the people who are buying their first place, which is often under $417K, and therefore not impacted by the jumbo rate jump. They are, however impacted in another way. They usually have less of a down-payment (because they’re not rolling over equity from a previous home), and are borrowing more than 80% of the purchase price.

2) For all borrowers planning to finance more than 80% of the purchase, you can afford less. This one worries me less—one, because only 15% of the loan is going to have a significant jump in rate, and that’s a whole lot better than having it hit the 80%. Second, there exists an option to borrow 95% as one trust and pay PMI. PMI, which historically was a dirty word for borrowers, is more acceptable now because in 2007 it’s tax deductible, same as interest. Boy, did they pick a good year to change that rule! So the 95% trust, as long as it’s not jumbo (see impact #1) should keep the payment roughly what a borrower was planning two weeks ago.

I’m sure this will continue to be a front-page crises for a few weeks. I’ll write more as the situation evolves. But I still stand firm in my conviction that if you are:

- Financially able to buy: good credit, a reasonable budget, about 8% of the purchase price in savings, and
- Your life situation calls for buying instead of renting: will be in this area for 3 or more years, you have reasonable expectations of what you get for the money, and you recognize that even a flat return on an investment is better than rapidly increasing rents (see Rent vs Buy calculator post),

Then this is still a good time to seriously consider buying.

FAQ: What is PMI?

Private Morgage Insurance (PMI) is required by a lender when a buyer has less than 20% or the purchase price as a downpayment (this is where the "I need 20% down" myth originated.) The buyer pays the premium but the lender is actually the one insured. Once the equity in the property reaches 80% (either via paying down the balance or an increase in market value of the property), the buyer can cancel the insurance. (Note: This insurance is NOT the insurance that must be carried on FHA mortgages, often touted as advantageous for first time buyers. FHA loans carry a different type of required insurance that lasts for the life of the loan.)

Prior to 2007, PMI was not tax deductible--just a fee that a homeowner had to pay. This resulted in "piggyback" loans--second mortgages that are tacked on to first mortgages. These second mortgages often carry slightly higher interest rates, but the benefit to the borrower was that the two loans in combination added up to more than 80%, and thus the buyer could replace non-tax-deductibe PMI with tax-deductible interest on the second mortgage. You often see these loans referred to as 80/15/5, or 80/20; the first number is the percent of the purchase price borrowed on the first trust (loan), the second number is the percent borrowed on the second trust, and the third number, if there is one, is the amount of the downpayment.

Starting in 2007, PMI is now fully tax deductible IF you're income is under $100,000. So far, this applies only to loans closed in 2007, so we'll have to see if this benefit stays in place. If you qualify for this deduction though, it may be advantageous to take one 95% loan, all at the same, lower interest rate, and pay the PMI, since it's now tax deductible just like mortgage interest. Everyone's situation is different, so consult a mortgage lender you trust and ask him to run the scenarios to see which option is more beneficial for you.