Why does your calculator want me to put 20% down?!

I offer a popular mortgage calculator on my website at www.AroundCU.com/calc that you can use to determine what your mortgage payments will be on a home that you are interested in. You can also get to this mortgage calculator by clicking on the ‘Mortgage Calc’ link in the tabs at the top of any home’s information.

From looking at how clients use my website, one thing that I have noticed over and over again is that people quickly change the percentage of down payment on their dream home from 20% to something smaller. Usually 0%. Alas, for the average homebuyer in today’s economy it just isn’t realistic to make that drastic of a change. I’m not choosing 20% as a starting point because I am evilly wanting you to see a lower monthly payment. Read on, dear client, to find out the motive.

Whenever you purchase your new home, you have a couple of different ways you can pay for it. You can pay cash, which is great; but most of us don’t have enough cash to do this. Or, you can get a mortgage from a lending institution, like a bank. Once the bank has determined that the home is worth a certain amount (which it determines by having an appraisal done) and has determined that you are credit-worthy, it will be happy to pay for the home on your behalf, with a few caveats. Let’s say that you have decided to pay $150,000 for a home, and the appraiser determines that the home is worth exactly that: $150,000.

The bank could loan you the full $150,000 but they are very hesitant to do that. The bank wants to make sure that, if anything goes wrong, that they will be able to get their money back. Just because your home is worth $150,000 right now doesn’t mean that it will be worth $150,000 a year from now. While we would all like for homes to increase in price each year (and, over time, they have trended upward in value) the simple fact is that this doesn’t always happen. The mid and late 2000’s are a good example of this. Most homes were worth less in 2008 than they were in 2006. So, the bank wants to build in a little bit of “buffer” into what it is willing to loan you. Let’s say that the home drops in value 10%, down to $135,000. If the bank had loaned out the full $150,000 they would be in danger of losing $15,000 if you decided to sell your home. To prevent this situation, and to help make sure that you are “serious” about buying a home, the bank typically wants you to put up some of your own money (what is called the “down payment”). This way, the bank doesn’t have as much invested. (pay attention: your question is about to be answered!) The most common amount that the bank wants you to provide up front is 20% of the sales price of the home.

By providing 20% of your own money, the bank would then have $120,000 invested (in the previous example) and you would need to have $30,000 to add to that amount when you close on your new home. This means that you would start paying interest on $120,000 instead of $150,000 once you buy, and your monthly mortgage payments will also be less than if you had loaned $150,000.

You might be telling yourself at this point that there isn’t any reason to continue looking for a new home. You might think that there isn’t any way that you can come up with $30,000 (for this example). Fret not. While 20% is the most common down payment amount that banks require, there are several programs out there (some sponsored by the government; some not) that, if you qualify for, can put you in a new home with a lot less than 20% down. I’m not a mortgage lender, but I know a lot of different lenders that can help you wade through all of the options. Contact me and I will do my best to make sure that you have all of the options available to make the best decision you can regarding your new home.

By the way, while we are talking about percentage down payment requirements, be aware that if you are wanting to purchase homes as an investment (great idea!) that you will likely need 25% down for a normal mortgage. Again, though, there are ways around this. And, there are a whole host of other issues (PMI, etc. etc.) that I haven’t talked about. Just ask! Don’t let the percent down prevent you from fulfilling your dream of home ownership or rental income.

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