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Saving
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Down Payment

by Michael Licamele

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Saving for a down payment on a home can be one of the most challenging tasks a young family faces in the quest for home ownership. Creating a down payment savings plan and sticking to it will help potential buyers reach their goal of home ownership faster.

Down payment requirements for 2012 are back to the same requirements from before the most recent mortgage and housing meltdown. For 2012, the basic down payment requirements are as follows:

Standard Fannie Mae/Freddie Mac Conforming for mortgages up to $417,000 loan amount: 5%
High-Balance Fannie Mae or Freddie Mac up to maximum limits in each region: 10%
FHA loan with credit score of 620 or higher: 3.5%
FHA loan with credit score between 550 and 619: 10%
Veterans Administration (VA) loans: 0% (yes - 100% financing)
USDA Rural Development loan (if your area qualifies - see below): 0% (yes - 100% financing)
Jumbo mortgage purchase loans for amounts above high-balance limits: 20% - 40%

All of the rules for down payments changed in 2008 back to the standard down payment programs of the past. If your home is located in a USDA lending area, then you could participate in the USDA zero down payment mortgage program. Veterans can also still purchase homes with zero down payment as well under the VA mortgage program. Otherwise, you will need a minimum 3% to 3.5% down payment to participate in FHA, Fannie Mae or Freddie Mac programs.

The purchase of a home usually entails saving for three up-front costs. The down payment is the largest part and is a percentage of the total purchase price of the house. As the economy has improved and home prices have stabilized in recent years, down payment requirements have dropped considerably. Today, first time home buyers can still purchase a home with no down payment only with the VA or USDA programs. However, putting even a small down payment down of 3% or more can help you get a much better interest rate.

In addition to a down payment, funds are needed to cover closing costs. Closing costs include all fees required to execute the sales transaction, such as attorney fees, title insurance, appraisals, points and tax escrows. While these charges vary considerably, most home buyers will need at least a few thousand dollars for closing costs.

Finally, home buyers need to show that after paying the down payment and closing costs they will still have some reserve funds to protect against short-term cash flow problems. Ideally, a home buyer will have at least three months' worth of housing payments available after closing. These funds do not need to be paid out; they simply remain in the home buyer's savings. Many programs today do not require any reserves at all.

As an example of total cash that used to be required, a home buyer purchasing a $200,000 home with a $1,750 monthly housing payment would need to have approximately $20,000 available. This includes $10,000 for a five percent down payment, approximately $5,000 for closing costs and about $5,000 in payment reserves. After closing, the home buyer would have $5,000 left over.

Today, borrowers can purchase a home with either no down payment through USDA or VA or with a 3% to 3.5% down payment and in many cases have the seller or lender finance closing costs. With little or no down payment or closing costs needed at closing, borrowers only need to show that they have reserves. Even though a borrower might not need reserves for a loan program, it is a good idea to actually have money set aside in case of emergency.

Based on the requirements outlined above, future home buyers can develop a savings plan that will help them achieve their goal of home ownership in the near future. Since the down payment required depends on the purchase price, a home buyer should meet with a mortgage lending professional to determine how large a mortgage can be obtained. The maximum loan amount will determine the approximate price range in which a home buyer should be looking. For example, a home buyer whose income will support a mortgage of $190,000 can look for homes with a price of about $200,000 and plan to save a down payment of at least $6,000.

Before starting a savings plan, a future home buyer needs to determine his or her current financial position. This includes reviewing all assets and liabilities, developing a budget and planning how much to save each month. When analyzing total current assets, a consumer should not overlook any source of funds. In addition to all checking and savings accounts, many people have CDs, stocks, mutual funds and savings bonds. Retirement funds such as a 401k or an IRA can be counted toward the payment reserve requirement. Some 401k plans even allow employees to borrow against the plan. Proceeds from borrowing against one's own retirement funds can be used toward a down payment.

By subtracting all current financial assets from the amount of funds needed to purchase a home, one can determine how much needs to be saved. A cash flow budget should then be prepared to determine how much can realistically be saved monthly. Some sacrifices of non-essential items may need to be delayed temporarily in order to meet each monthly goal! No matter how a home buyer accumulates funds to purchase a home, careful planning will always smooth the road to home ownership.

As savings increase and the opportunity to purchase a home draws nearer, home buyers need to make sure that all funds saved are fully verifiable. Mortgage lenders have tightened verification procedures for down payments to insure that all of the funds a borrower claims exist and were not borrowed. The number one source of mortgage fraud in the 1980's was consumer misstatements about their financial assets.

Many would-be home buyers look into renting a home with an option to purchase as a method of saving a down payment. In these transactions, the seller/landlord will credit a portion of the monthly rent toward the purchase price. Only the portion of a rental payment that exceeds the fair market rent can be applied to the down payment. Few homeowners are willing to engage in this type of transaction. As a result, home buyers may be better off simply staying where they are, saving on their own, and then purchasing a home they really want.

Of course, the easiest way to save is to receive a gift from a relative. More than half of all first time home buyers receive gift funds from relatives in order to help with their down payments. While Fannie Mae and Freddie Mac mortgage loans require that a borrower putting less than 20% down must have at least 5% of their down payment be from their own funds, FHA allows the entire down payment to be gift funds. No matter how a home buyer accumulates funds to purchase a home, careful planning will always smooth the road to home ownership.


Michael Licamele is the Editor of MortgageAlmanac.com.


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