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The end of the 0% down paymentThat train has left: If you want to buy a house now, you'll have to put something into the deal. Here's what you need to know if you're looking to buy.By Liz Pullman WestonDecember 18, 2008 Mortgage lending has changed dramatically in so many ways, but one of the most critical developments for homebuyers has to do with down payments. Now you need one. You didn't at the peak of the mortgage lending boom. Lenders were delighted to loan you the full purchase price of a house. Waiting to build up your savings seemed foolish because ever-rising home values in many cities could quickly price you out of desirable areas. Today, as foreclosures skyrocket and home values tumble, lenders are demanding that borrowers have skin in the game, as I wrote in "Need a loan? Borrow like it's 1975." Though you can buy a house with as little as 3% down, a bigger stockpile can lower your payments and increase your mortgage options. Here's how to figure out how much you need and where to get it. To start, there are three break points you need to know: 3%, 10% and 20%. The 3% option Borrowers who can scrape together just 3% of the purchase price (3.5% starting Jan. 1) basically have one choice, but it's not an awful one: Federal Housing Administration loans. These loans:
Selling costs typically eat at least 6% of a home's value, so you wouldn't be able to sell the home for what you owed -- at least not until home prices start rising again, which isn't going to happen soon. (Some optimistic economists predict we'll hit the bottom for real-estate prices next year, while others believe recovery won't begin until 2010 or beyond.) Owing more on your home than it's worth is no big deal if you can wait it out. But if you lose your job or otherwise have to sell, you'll have three bad options: Come up with extra cash to pay the lender, try to get the lender to accept less than it's owed in a short sale, or submit to foreclosure. The 10% plan You also start the game with at least a little equity. Yes, that could be wiped out if real estate in your area continues to tumble, but at least that wouldn't happen as fast as it would had you bought with less money down. You'll still have to pay private mortgage insurance because you aren't putting 20% down. The annual premium of 0.52% would add $87 to your monthly payment for a $200,000 loan, for a total of $1,217.81. The subprime meltdown has meant a return to the traditional mortgage: 20% down for 30 years at a fixed rate. Impossible? We look at 3 cases where people are going that well-worn route -- without Wall Street jobs or trust funds. The 20% plan If you can pay a fifth of a home's purchase price, you should be able to ride out the real-estate swoon without losing all your equity. But a bigger down payment doesn't translate into a lower interest rate. Recent rates on conventional loans with a 20% down payment were 6.125%, half a percentage point higher than those with a 10% down. But you won't have to pay private mortgage insurance, so your monthly payment to borrow $200,000 will be about the same as with a 10% down, or $1,215.22. (I'm assuming you'd use the bigger down payment to buy more house. If you instead used the payment to reduce the amount you borrowed to $180,000, your payment would be $1,093.70.) A 10% down payment gets a slightly lower rate because lenders are somewhat better protected with private mortgage insurance, Hackett said. PMI protects lenders against losses down to 75% of a home's value. You may not always have much of a choice about how big a down payment to make. If you're seeking a so-called jumbo loan, for example, lenders may demand down payments of 30% or even more, said Michael Moskowitz, Equity Now's president. (Any loan above a certain dollar amount can't be sold to mortgage agencies Fannie Mae and Freddie Mac. The limit varies by region, but as of Jan. 1 any loan over $625,500 will be considered a jumbo.) Get out those magic beans So, how do you get the extra money to make a bigger down payment? Here are the three ways I like best: Savings. Building your down payment from your current income can be slow going, but it has a definite advantage: You learn to live below your means, a helpful skill when you're going to be a homeowner. The discipline of controlling your spending can help ensure you keep the home you finally buy, particularly if you make sure to have at least two months' worth of payments left over in savings after you cover the down payment and closing costs, which typically run 2% to 5% of the loan. These days, there's not much penalty for waiting because:
A gift from your folks or other relatives. If they have the cash to spare, a gift from a loved one can get you into a house more quickly. A gift is far better than a loan, by the way, since any borrowed money affects your debt-to-income ratio and could reduce the amount of mortgage for which you can qualify. Less desirable sources of funds include: A 401(k) loan. The loan can become an inadvertent withdrawal if you lose your job and can't pay the money back quickly. In these uncertain times, with the risk of unemployment high, that's not a chance I'd recommend you take unless you're one of the few with a rock-solid job. A $10,000 IRA withdrawal. You can bust up to $10,000 out of a regular individual retirement account for a home purchase without paying early withdrawal penalties, but you will have to pay applicable income taxes. If you're in the 25% federal tax bracket, that could set you back up to $2,500, plus any state and local taxes -- a pretty stiff price. You can take the money tax-free out of a Roth IRA, provided you've contributed at least as much as you're withdrawing (any excess would be considered taxable gains). But remember that taking the money now can cost you later. A $10,000 withdrawal now can cost you $100,000 in lost future retirement income, assuming 8% average annual returns over 30 years (and yes, Virginia, that's a reasonable assumption considering historical returns). In either case, you should talk to a tax pro before taking any money from a retirement account. Also, I should make the point here that you don't want to commit every cent you have. Having an emergency fund is important in any economy but particularly so now. Lepre urges his customers to make smaller down payments and accept private mortgage insurance, if a larger down payment would deplete their savings. With recession and rising layoffs, he thinks homeowners should have up to 12 months' worth of payments in an emergency fund. |
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