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Down Payment Considerations for First Time Home Buyers


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TERMINOLOGY

In today's mortgage world, there are several down payment considerations for first-time home buyers. In years past, buyers were required to put down 20 percent of the home price in order to get a loan. Those days have long past and there are now lots of down payment options for first-timers.

The Gold Standard – 20 Percent
Even though most lenders do not require a full 20 percent anymore, it is still an important number. If the homeowners should default and the bank has to sell the home, a 20 percent down payment will provide a profit buffer, allowing the bank to offer the property at a deep discount to sell it off quickly.

And there are certainly advantages for buyers who make down payments of 20 percent or more. They usually score much better interest rates on their mortgage loans than those who put down less. A large down payment also means lower monthly payments. Plus, that amount of up-front equity provides homeowners with some cushion if they have to sell sooner than expected or in a down market. These buyers do not have to pay Private Mortgage Insurance either.

Private Mortgage Insurance
Private Mortgage Insurance (PMI) is an insurance policy that lenders require buyers to purchase if they put less than 20 percent down. This insurance covers the lender, not the homeowner, for up to 20 percent of the home price if the homeowner defaults and goes into foreclosure. Buyers are required to pay for this insurance until the loan-to-value ratio reaches almost 80 percent. While this can be a great alternative to saving up for a large down payment, PMI premiums can be costly, running between 0.5 percent and 1 percent of the loan amount per year.

Piggyback Loans
There is an alternative to paying PMI. Some lenders will allow borrowers to take out two mortgage loans – one for 80 percent of the cost and a second mortgage for the remaining balance (20 percent minus the down payment). The downside is that the interest rate on the second loan will be much higher than the first home loan, perhaps even 3 to 4 percent higher.

Down Payment Gifts
Yet another option, for those with generous friends or family, is to receive part or all of the down payment as a gift. Some loan programs will allow first-time buyers to use money from almost any source that does not benefit from the sale. This can certainly give borrowers a head start on their way to home ownership.