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.

What Does the Fannie & Freddie Bailout Mean To Home Buyers?

Big news over the weekend and today is that the Federal government is 'bailing out' Fannie Mae and Freddie Mac, who lacked enough access to capital to keep the secondary mortgage market going. While buyers and sellers might initially think that this is bad news, it's actually good, as evidenced by the 300 point market rally at the opening bell today. The markets are glad that what was an 'implied' guarantee is now an explicit one and the markets like transparency.

This is critical to the mortgage industry: Freddie and Fannie buy mortgages that are originated by banks, then package those loans up, slaps a guarantee on them, and sell them to investors. This helps transform what would normally be a very illiquid and long-term investment (30 year mortgages) into a very liquid asset: mortgage-backed securities. This keeps access to capital for borrows high, and interest rates low. Both Fannie and Freddie were chartered by Congress for specifically this purpose.

Before you start slamming this as another taxpayer funded bailout, remember that Congress has control of both their charters and heavily regulates what they can buy and sell. Both companies, though publicly traded, have many restrictions on how they operate their businesses. (The government, for example, sets the conforming loan limit of $417,000, now $729,750 in our area, but due to drop back down to $625,000 at year end). If the governments wants the right to legislate how a publicly traded company--presumably accountable to shareholders--is going to operate, then it's only fair that when things get mucked up the government needs to help out.

In terms of rates, we should expect to see conforming/jumbo-conforming rates drop in the coming weeks by as much as a percentage point.

If you're on the fence about buying, this means the (possibly temporary) return of rates in the 5.5% range! For those of you who recently purchased, keep a close eye on rates -- if rates drop to a full percentage point below what you have, it may actually be worth it for you to refinance. Discuss this with your lender.

Client Testimonial

I got the nicest letter today from a first time buyer client couple. It really made my day and I wanted to share it:

Katie,

We wanted to thank for your guidance and tremendous service during our condo buying process. Given the issues with FHA and our lender situation, this process had a lot more twists and turns than we ever imagined. But at the same time, we were reassured that your innovative solutions and attention to detail would get us through and it did!

Honestly, as we told you, before attending your home buying seminar and leveraging your expertise during our condo purchase, our opinion of realtors was not the highest. However, after working with you, that has changed. We really appreciated your vast array of knowledge as well as your super prompt response to what at times were our incessant questions. Plus, the little extras like the website of preferred vendors, use of the pick up truck, and letting us borrow your dolly helped us to move in.

Finally, thank you for the card. It now graces our new stainless steel fridge and we have already put those gift cards to good use.

We had no idea how stressful this process could be and honestly, we could not have done this without you.

Thanks Katie!

If you're a first time buyer, please contact me. I'd love to help you find a home, too!

IndyMac Closing - Impact on Their Bank-Owned Properties?

Indymac Bank today announced they are closing down their loan operations and laying off 3800 people. While this is certainly bad news for the lending industry as a whole, it's also bad news for buyers on two fronts. First, and most obviously, fewer lenders means less liquidity.

The ripple effect though will impact foreclosures already on the market--many of which are owned by Indymac. Two effects here that I can see right off the bat: first, Indymac requires offers to be submitted by an Indymac pre-approval letter (I hate this practice whenever a lender does it...but that's another post.) I assume this requirement will be lifted now that Indymac is no longer underwriting? Or will buyers be in an endless loop because they can't get an Indymac letter but somebody in the REO department has a checklist somewhere and that box isn't checked?

Second, if you thought it took Cubicle Joe in Idaho a long time to get you an answer on your foreclosure/short sale before, how much longer do you think it will be now that he's worried his employer might go out of business? My guess is he'll spend a lot more time at the water cooler gossiping, saying goodbye to his friends in underwriting who got let go, and polishing his own resume. Your timing risk just increased exponentially.

Buyers, lower your expectations when making offers on Indymac properties, and make sure you have a back up plan.

Sellers, if your buyer's lender is Indymac, ask for a new lender letter asap; or be prepared to re-list your home.

Readers: Are you learning about these developments from me via this blog instead of from your own agent? Shame on your agent for not being plugged into the market. You might want to explore the possibility of finding a new agent.

5% Down Payments Coming Back?

Just when you thought that FHA (which requires only 3% down) was the only way to get away with less than 10% down, it appears that Fannie Mae is changing its policy. Fannie had recently slapped a 'declining market' label on the entire Washington, DC, area, which had the effect of increasing the minimum down payment of 5% to 10% for most buyers. But according to the Wall Street Journal, as of June 1 that policy will end.

This is huge news for easing credit conditions for new buyers, many of whom have trouble getting together 10% plus the closing costs. FHA, which requires only 3% down, had seen a huge uptick in activity in recent months as a result. Where Fannie goes, Freddie is likely to follow, so look for improved credit conditions and more loan options in the near future.

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.

Foreclosure Risks: Financing Complications

Buying a bank owned property creates a multitude of financing risks—not because a buyer may have any particular problems with their credit or loan otherwise, but simply because the transaction is complicated and timing is difficult to control (read previous post on timing difficulties in buying a foreclosure here.)

It’s critical that buyers protect themselves with appropriate financing contingencies (and make sure that the protections you want are not negated by those pesky bank addenda – read post here.) Buyers take on enough risks in buying a foreclosure—don’t expose yourself to unnecessary interest rate risk as well. Let’s take an example. You make an offer on April 1 (no, there’s no hidden message there just because I’m using April Fool’s Day as my example) when rates are at 5.875%. The bank takes four weeks to get back to you, at which time rates have jumped to 6.25%, or even worse, the 10% down program you were planning to use is no longer available and now you need 15%, which you may not have. Sure, you can still back out of the contract (the upside of having to sign off on the bank addenda mentioned earlier), but obviously the situation is far from ideal. Let’s take a riskier situation: the contract is ratified and the buyer has signed off on the bank addenda. The buyer locks into a rate for 30 days, and settlement is scheduled for day 27. But the week before settlement the bank has a problem with the deed, and needs to delay settlement for a few days/weeks. So much for that rate lock—now your financing is floating with the market, and you take on all that interest rate risk.

Another pitfall to look out for is inconsistencies between your type of financing and the property condition. FHA is a great example; FHA loans require that repairs for issues that “rise above the level of cosmetic defects, minor defects, or normal wear and tear.” In a “normal” sale, the seller has to pay for those repairs. But, as we’ve discussed before in the property condition post, the bank is not about to take their time to hire plumbers and electricians to come in and fix those items—the sale is “as is.” The bank won’t pay. You don’t own the property so even if you wanted to repair it yourself, you’d have some hoops to jump through. So the property needs repairs, the bank won’t do them, and so FHA won’t fund your loan. (There may be some creative ways to still make this happen, but I can’t give all the secrets away here, can I?)

So to wrap up, don’t underestimate the financing risks you take on in buying a bank owned property. It’s not a bargain unless you’re adequately compensated for that risk, in the form of a lower-than-market price.

Read more: Foreclosure Risks: Unpredictable Transaction Timing

Read more: Foreclosure Risks: Bank Addenda

Read more: Foreclosure Risks: Property Condition and Inspections

FAQ: Buyer's Closing Costs

Many buyers are aware that they have fees related to the purchase of a new home—a rough guide is 2.5%-3% of the transaction value--but what are these fees, and are there ways to minimize them?

First, a few clarifications. Both buyers and sellers have closing costs in a transaction; the sellers’ are typically much higher (because they pay both real estate brokers) than the buyers’. These fees are typically paid at closing—they come out of the sellers’ proceeds, and the buyer can either pay cash, or can negotiate to have their portion of the closing costs paid by the seller (read more here.)

For this post, I’ll focus on the buyer’s fees. A lender should provide you with a Good Faith Estimate (GFE) when you apply for a loan. This GFE is essentially an estimate of your “HUD-1” form, which you will receive at closing. Each lender has their own preferred format, but you should be able to compare apples-to-apples by looking at the section headers, or, even better, the line item numbers. It’s important to note, though, that lenders only control certain sections, while others may be simply based on their own experience. When comparing lenders, it’s important to focus only on the line items that the lender actually controls.

The fees vary by jurisdiction, broker, and settlement attorney, but a good way to categorize them would be:

• Prepaids – These are generally required by the lender, and may include prepaid insurance, prepaid property taxes, and prepaid interest. Another common prepaid item is condo/HOA fees. These vary based on the day of the month that you close, since they are pro-rated between buyer and seller.
• Points – A point represents 1% of the loan balance and are charged by lenders. This, along with the fees, can easily amount to thousands and thousands of dollars, so it’s important to discuss this with your agent and your lender.
• Fees – These are fees charged by real estate brokers, settlement attorneys, and lenders, and are the toughest to judge for "reasonableness" without experience. These vary widely, particularly among lenders. Some real estate agents will pay their broker’s fee on your behalf—be sure to ask them. For lenders, whose fees can be substantial, it’s important to know early in the process what they’ll charge. These fees can generally be found on your Good Faith Estimate in the 800 section, but look in the 1300 “Additional” section too. Broker's and attorney’s fees are scattered throughout the closing statement sections.
• Title Insurance – This is paid by the buyer and, depending on the policy, can amount to thousands of dollars. It’s a one time charge that covers you in the event of a problem with the chain of ownership. See my post on how to save some money with title insurance here. This is in the 1100 section.
• Government and Transfer Charges – Paid to the local jurisdiction. These can be quite substantial—for example, in the District of Columbia, the transfer (paid by the seller) and recording taxes (paid by the buyer) are 1.1% each. Northern Virginia sellers just had big increase (from $1 per $1000 in value to $5 per $1000) in their transfer taxes.

Read more about how to spot “junk fees” in my post here. This is just a high level summary of some of the most common items on a HUD-1, so be sure to ask your agent to walk you through the expenses and strategize with you on how to keep them to a minimum!

First Time Buyer Assistance Programs

Believe it or not, this is a perfect time to start planning for a home purchase in the spring, especially if you're a first time buyer. The reason I say that is that I find it takes most of my first time buyer clients at least 3 months from the time they first speak to a lender until the time they move in. If someone has special financing restrictions, or isn't quite sure yet what they're looking for in a home or neighborhood, then it takes more in the range of 4-6 moths!

Financing in particular takes some very advance preparation--saving for downpayments and closing costs, sticking to a budget, and fixing any credit issues can take quite a long time. With the cost of housing (still) being what it is in this area, it's especially difficult for first-timers.

If you're thinking of buying in DC, though, there's a special program that may help you out. Like many special programs, there's a bit of paperwork involved, so it's best to get started far in advance. HPAP enables lower and moderate income buyers (that is, making less than $70K per year) to receive up to $70K in funds in the form of a low-interest loan. In addition, buyers can receive up to $7000 in closing costs free! Closing costs average 3% of a transaction, so on a $300K condo, that covers almost all of them! Tough to find a better deal, but there is paperwork and classes involved so get started now if you're thinking of buying in the spring. Get more info here, and contact me to discuss how best to coordinate your search using HPAP and other programs.

There are lots of other programs too; here is a link to some other area programs.

Confused about how to start your search? Attend a free first time home buyer class in Arlington, VA.

FAQ: ARM Loans

A very informative article about shopping for ARM loans (more popular given the recent jump in both jumbo and second trust rates).

The bottom line is to show around for rates, and know which questions to ask.


- Determine the initial interest rate and how long you will get it
- Ask if it’s a negative amortization loan
- Determine what the rate increase will be and how often it ‘resets’
- Determine what the annual and lifetime ‘caps’ are and how quickly you might reach them – this gives you the worst case scenario on your rates. Make sure you understand what the payment is at those rates.
- Know what the index (LIBOR, T-bill, etc) and spread is
- Know whether your loan is a balloon, and what term the balloon is, or based on a 30 year amortization

The author wisely points out to be wary of internet lenders. I’ve seen cases of this myself—even if the rate does turn out to be as low as they claim, keep a careful eye on the fees they charge but are buried somewhere in the Good Faith Estimate (GFE), and often not in the “Lender Fee” section where you’d expect.

Speaking of fees, that’s the only I’d add to this list—always ask what the fees are, and what they’re for. Always ask about things like: administrative fee, underwriting fee, processing fee, application fee, document fee, and warehousing fee. Don’t get me wrong—a lender needs to make money too, but these are the fees you should be comparing, and negotiating. And also understand the origination fee and any discount fees, especially as it relates to the interest rate you’re being charged. Two lenders might both be quoting 7%, but one of them is charging you a “point” (equal to one percent of the loan value and listed as a “discount point” on the GFE) to get it!

As always, you can contact me with any questions, or to look over your GFE with you. I can’t negotiate it for you, but I can tell you which things I’ve seen before and which things I haven’t. I routinely do this with my clients.

And of course, the way to avoid many issues is to work with a reputable lender in the first place!