There are so many loan options out there including those with very little down payment requirements, such as the FHA loan with only 3 percent down required. So why should you worry about saving up for a down payment when you can get your hands on a loan with such little money? The problem is that the less money you put down, the higher risk you pose for the lender. If you are borderline eligible for a loan, that higher down payment can make you more attractive to the lender, while the minimum down payment makes your loan get declined. The down payment is like your portion of the investment – the more you have in the game, the more likely you are to make your payments. If you do not make your payments, the bank is stuck with your home and a large debt on their hands.
An obvious reason for a larger down payment is the ability to have lower payments. This can be a Catch 22, however. Are lower payments really going to help you if you spent all of your money on the down payment? You need a perfect balance. Saving up for the down payment can help to get your loan approved along with keeping your payments down. This is especially important if you plan on staying in the home you purchase for a long time. If it is a short-term arrangement, then putting a large amount of money down is not necessary because paying the principal down is not going to be as important because you will move before you even start hitting the principal on your mortgage payments. If your home is a long-term purchase, however, getting that principal amount down means lower payments and a better chance at getting the loan paid off early.
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A Compensating Factor
Lenders are always looking for compensating factors on loans that are not considered “perfect.” There is no recipe for the perfect loan, but it means great credit, a low debt ratio, and plenty of reserves. What if your credit is not great though? Maybe you are borderline, which today could mean a credit score that does not seem low to you. Some lenders may even consider a credit score of 650 low. In this case, a large down payment would help make your loan look more attractive. Even if your credit score is low because of some blemishes that you corrected, but have not increased your credit score dramatically, you are putting a large investment into your home, showing that you are serious about wanting the home and making the payments. The same is true for any other factors you need to make up for whether it is a higher debt ratio or a new job without a 2-year history. The more money you put down, the more the bank at ease you put the lender.
Lenders base the cost of your loan on your risk level. If you put down the minimum amount required, such as 3 percent for an FHA loan, you are a higher risk than someone that puts down 10 percent, for example. The person that puts down 3 percent will likely have higher origination charges from the lender than someone that put 10 percent down. This is done in order to make up for the level of risk you provide the lender. The riskier your loan, the more likely it is that the lender will not make the interest charges for the long-term on your loan because you may default. If you have a larger investment in your home, however, you are more likely to continue making payments, which means the lender will make his profits and will not need to charge you as much up front.
Lenders look for a certain level of responsibility out of its borrowers. They are not going to hand out loans to just anyone – you must be able to show that you are financially responsible. This is partially shown with your credit score, but if your credit history has blemishes or you do not have an extensive credit history yet, you cannot show your level of responsibility. The other way to show it is with the amount of money you saved for a down payment. Showing that you can put down 10 percent or more on your home shows that you can save money and be responsible with your income. The higher the down payment, the more responsibility you show and the more likely it is that the lender will approve you.
Putting money down on a home is tricky, but it is also important. Lenders take the down payment into consideration when determining your eligibility for a loan. Remember that the amount you put down is directly correlated to your level of risk. The less money you invest in the home initially, the higher risk you pose to the lender. In the end, this means that you could end up without the loan you need because of a lack of a down payment. In addition, if your goal is to keep your payments as low as possible, putting more money down up front can help you achieve that goal because the lender will give you a lower interest rate and charge less costs as a result of the amount of money you invest in your home. If you plan to purchase a home, start saving now so that you have the money for the down payment that is necessary for good loan terms.Click to See the Latest Mortgage Rates»