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.

FAQ: Earnest Money Deposits

I love the Post's Saturday Real Estate Mailbag. There's always something interesting in there. (Though if you read it long enough, you do start to see the same questions over and over.) Here's a good tried-but-true one that I often get from clients -- how much should you put as earnest money? What IS "earnest money," anyway?

Simply put, earnest money is a personal check that you write (payable to your real estate broker or another third party) that accompanies your offer on a property to indicate to the seller that you are sincere, or "earnest," in your endeavor to buy their property. It's a "good faith deposit" on the property. Once you agree to terms, the seller will be removing their property from the market and passing up potential future offers, so it's only fair that they have something more tangible than your signature to rely on. It's a buyer's way of putting "skin in the game."

The check gets cashed upon contract ratification, and the deposit is held by that third party until settlement, at which time it is applied to your downpayment or closing costs. In the event of any overage, it's refunded to you at settlement. In the event of a default by the buyer, the seller theoretically can claim that deposit (though in reality it's extremely difficult to make that happen.) Here's a great FAQ from the mailbag:

DEAR BOB: What is the normal earnest money deposit that should be offered by a buyer for a $350,000 condominium? Is it a percentage of the sales price, or is it based on something else? -- Ottilia C.

DEAR OTTILIA: There is no "normal" earnest money or good-faith deposit for the purchase of a residence. At a minimum, however, it should be 1 percent of the sales price to show serious intent. That would be $3,500 in your situation.

If you are making an offer substantially below the seller's asking price, a larger deposit can impress the seller. However, your deposit should not be more than 5 percent of the purchase price. Always make your check payable to the firm you want to handle the closing of the sale, such as a title-escrow company or perhaps a real estate lawyer -- not the seller.

Of course this column is syndicated nationwide, so may not represent the typical transaction in this area. Though there is no specific requirement, in my experience and in the current buyer's market, you should be prepared to put about $5000 as a deposit for a transaction value up to about $350K, $10,000 up to about $600K, and for anything higher than that $20-25K would likely be considered sufficient. Obviously the more you put down, the more seriously your offer will be considered, particularly in a competitive bid situation (yes, they still happen!)