Down Payment 2

Definition of "Down Payment"

Samantha  Hartley-Bullen
Samantha Hartley-Bullen Century 21 Signature Real Estate

The difference between the value of the property and the loan amount, expressed in dollars, or as a percentage of value. For example, if the house is valued at $100,000 and the loan is for $80,000, the down payment is $20,000 or 20%. Down Payment and LTV: In percent, the down payment is one minus the LTV the ratio of loan to value. In the example, the LTV is 80%, and 1 - LTV is 20%. Lender requirements are always expressed in terms of a maximum LTV rather than a minimum down payment because maximum LTV does not generate questions about what a down payment is. Sale Price Versus Appraised Value: Home purchasers who pay less for a home than its appraised value frequently question whether they can use the difference as their down payment. They cannot. The rule is that the property value used in determining the down payment and the LTV is the sale price or appraised value, whichever is lower. The only exception to this is when the seller provides a gift of equity to the buyer, as discussed below. Gift of Equity: Gifts of equity arise when a house is sold for less than its market value, almost always to a family member. In this case, the lender recognizes that the house is being priced below market and will accept the appraisal as the value. Most lenders in such cases require two appraisals, and they take the lower of the two. Cash Gifts: Lenders will accept cash gifts for some part of the down payment, usually not for all of it. While the rules vary for different programs, it is common to require that the borrower contribute 3% of the down payment.Lenders require a donor to sign a gift statement affirming that the funds provided are a gift rather than a loan. The lender wants assurance that the transfer of funds imposes no repayment obligation that could put the mortgage loan at risk. Sometimes, however, borrowers induce friends or family members who do not want to make gifts to lend in the guise of a gift. For example, a house purchaser needs the equity in his current house to make the down payment on a new one, but must close on the new one before the old one is under contract. Because there is ample equity in the old house, the buyer asks a friend or family member to lend the money needed for the down payment, to be repaid when the old house is sold. This is a bad idea. Not only is it a fraud against the lender, it also involves risk to the donor. Contingencies that could result in not being repaid include a sharp drop in the value of the old house before it is sold, or the sudden death of the home purchaser. The home buyer in this situation should be advised to take out a home equity loan on the old house, which can be repaid when it is sold. A home equity lender has a lien on the house and has diversified its risk over many loans. The lender pretending to be a donor has neither. Land as Down Payment: Many people acquire land in order to build on it later, and the land serves as part or all of the down payment. If the land has been held for some time, the lender will appraise the completed house with the lot, and the difference between the appraisal and the cost of construction is viewed as the down payment. Home Seller Contributions: Home sellers often gift buyers, raising the price by enough to cover the gift. The purpose is to improve the buyer's ability to purchase the house by reducing the required cash. The practice is legitimate, provided it is done openly and conforms to the guidelines of lenders and mortgage insurers. For it to work, the appraiser must say that the house is worth the higher price. Contributions Under FHA: On FHA loans, individual sellers can contribute up to 6% of the price to the buyer's settlement costs, but nothing to the down payment. However, FHA allows approved nonprofit corporations to offer down payment assistance using funds provided by sellers. Investing in a Larger Down Payment: A larger down payment is an investment that yields a return that consists in part of the interest rate on the money you aren't borrowing. No-Down-Payment Loans: The availability of no-down-payment loans (NDP's) is a strength of the U.S. mortgage system and also a weakness. Some families become successful homeowners with the help of NDP's. Others, who shouldn't be homeowners, are enticed to try and fail. NDP's have high default rates. This has been a finding of every study of mortgage defaults that I have ever seen. One reason is that homeowners who borrow the full value of their property have less to protect should economic adversity strike. If they lose their job, or if property values decline temporarily, they lose less from a default than borrowers with equity. A second reason is that borrowers unable to accumulate a down payment have not demonstrated budgetary discipline and the ability to plan ahead. People able to save money every month before they buy a home are much more likely to meet their monthly mortgage obligations afterwards. In recent years, furthermore, lenders have become more confident in their ability to assess the willingness and capacity of borrowers to repay their mortgages. Using credit scoring and other tools, they judge that it is safe to give less weight to an applicant's ability to accumulate a down payment. Lenders protect themselves, furthermore, by charging higher rates on NDP's. The rate includes a 'risk premium' to cover the losses lenders expect from higher delinquencies and defaults. Some people are not cut out to be homeowners. When they default, the costs include not only loss of their house, but also having to find another one with all the disruptions to their lives that that typically involves. Plus their credit rating goes into the tank. If many defaulters live in the same neighborhood, the neighborhood can also tank. Securities as Down Payment: Some investment banks offer home loan plans where they accept the deposit of securities in place of a down payment. These plans delay the accumulation of equity in the house indefinitely. The customer begins with no equity, and if the payment only covers the interest for the first 10 years, which is a common feature, the only equity buildup is from appreciation in the value of the property. The theory behind this is that the consumer's overall wealth will grow more rapidly if the maximum amount is invested in securities.

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