Month: April 2014

How Much Do You Need for a Down Payment?

When you are saving money for your first home, it can be daunting to think about how much cash you will need to become a homeowner.

While there are FHA-insured loans that require just 3.5% for your down payment, those loans require you to pay mortgage insurance for the life of the loan, which will keep your monthly payments higher. Most conventional lenders offer home loans with either a 10% or a 20% down payment, although some lenders offer loans requiring as little as 5% down.

You will need to consult with a lender to evaluate your individualized loan options, but before you do that, you should consider the pros and cons of various down payment scenarios.

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Why a 20% Down Payment Is Ideal for Lenders

Mortgage lenders evaluate your credit profile, your debt-to-income ratio, your job history and your assets to make an educated guess about whether you will manage to repay your loan responsibly. A 20% down payment is viewed as ideal by lenders because you are investing a significant amount of your own money in your home and therefore the lender’s risk is reduced.

If you make a 20% down payment, you won’t have to pay private mortgage insurance. PMI provides insurance to the lender in case you default on your loan.

Buyer Advantages of 20% Down

In addition to eliminating the need for PMI, a 20% down payment will qualify you for a slightly lower interest rate than a borrower who makes a smaller down payment. Another benefit is that you will borrow less money, making your monthly payments smaller.

In addition, you will instantly have 20% equity in your home, which you can borrow against in the future or get back as part of your profit when you sell.

On the other hand, keep in mind that 20% of the average home price in the nation ($200,000) is $40,000. It can take years to amass that much cash and you will need additional cash for closing costs, cash reserves in case of an emergency and moving costs.

In the meantime, home prices may have risen and interest rates may have gone up, both of which will increase the cost of your purchase.

Smaller Down Payment Pros and Cons

If you make a down payment of 10% ($20,000 on the average home) or 5% ($10,000 on the average home), then you will be able to become a homeowner faster, since you won’t have to save as much cash. If you are able to save additional cash, it’s a smart idea to keep a robust savings account to cover emergencies and even anticipated expenses of homeownership such as maintenance and repairs.

There are some disadvantages, however, to making a smaller down payment:

  • You will need to pay PMI to your lender, which increases your monthly payments.
  • Your home loan will be larger, so your monthly payments will be larger, too.
  • Your interest rate will be a little higher, too, than for someone who makes a 20% down payment.
  • In order to qualify for a mortgage, your maximum debt-to-income ratio must be 43% or less, so a smaller down payment will make it harder to qualify for a loan.
  • The decision about the size of your down payment depends on a variety of factors including home prices in your market and your income. Find a good lender who will consult with you and help you make the best choice in the context of your individual financial plan.
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8 Things to Avoid Before You Buy a Home

If you have been approved for a mortgage for your next home, you might be assuming you can breathe easy now and just concentrate on packing and preparing for your move. Not yet.

While most of your hard work of building a good credit profile and amassing savings for a down payment and closing costs is behind you, it’s important to remember that your lender will recheck your credit just prior to your settlement date and will also verify a few details such as your place of employment to make sure nothing has changed.

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That’s the key phrase—“nothing has changed.” You must take care to maintain the same credit profile that led to your loan approval until your mortgage paperwork is completely signed.

Avoid the following actions to ensure a smooth settlement:

1. Don’t apply for new credit: It may seem natural to apply for a credit card at a home improvement store or a furniture store when you are about to become a homeowner, but applying for credit can lower your credit score. Not only will you lose a few points because of a credit inquiry, but if you are approved for new credit, a lender may worry that you will spend up to your new credit limit and then default on your loan.

2. Don’t close any credit accounts: You may be feeling that this is a good time to get your financial house in order by closing unused credit accounts or transferring your debt to a new credit card with a zero-interest balance transfer offer. While that’s a smart move financially, it’s a bad one for your credit score because you lose points when you have a higher usage of debt compared to your limit on one credit card and to your overall credit availability. Wait until your closing is complete before you make these changes.

3. Don’t move your money around without a paper trail: Your lender will need the most recent bank statements before you go to settlement, so if you have any unusual deposits you will need to provide complete documentation of where the money came from. If possible, it’s best to move the cash you will need for your home purchase into one account before you apply for a mortgage. If not, make sure you have complete and accurate records readily available.

4. Don’t increase your debts: In addition to your credit score, your debt-to-income ratio is extremely important to a loan approval. If you take on more debt you could be in danger of going above the maximum acceptable debt-to-income ratio.

5. Don’t skip a payment or make a late payment: One of the most important elements of your credit score is your history of on-time, in-full payments, so don’t get so caught up in your move that you forget to keep up with paying basic bills.

6. Don’t buy a car: You may be feeling that a new car would be a nice addition to the driveway of your new home. Resist that feeling. Even if you can easily afford a new car, the depletion of your savings or the addition of a new car loan could derail your mortgage application. Wait until after you have moved to switch to a new car.

7. Don’t change jobs if you can help it: While a job change could mean a raise or a path to a better future, it could also delay your settlement. Your lender needs to verify employment and will need paystubs to prove your new income before your loan can go to settlement.

8. Don’t spend your savings: You’ll need cash on hand at the settlement for your down payment and closing costs and your lender may even verify your cash reserves one more time, so make sure the funds stay in place.

In other words, no matter how hard it is at this exciting time, it’s better to do nothing than to do anything.