Why do lenders want borrowers to make large down payments on mortgage loans? After all, wouldn’t it make sense to assume that lenders would want people to borrow as much money as possible, since they would wind up paying interest on all the money? The truth of the matter is that lenders want borrowers who are serious, and who are more likely to pay the loan back without ever getting near foreclosure.

Historically, borrowers who make larger down payments are more likely to pay the loan on time and not default, whereas borrowers who make no down payment or a low down payment are more likely to not only be late in making monthly payments, but also more prone to eventual foreclosure. Lenders generally accept the idea that a borrower who is willing to make a large down payment is a borrower who is invested in a loan and will pay it back.  Not everyone, however, has the ability to whip out their checkbook and make a down payment on a home.  For this reason, there are plenty of other options available.

One of the most commonly known zero-down programs is the program offered by the Veteran’s Administration.  Anyone who was honorably discharged from military service is qualified to receive a home loan guarantee from the VA, and this makes it possible to receive a mortgage with no money down.  One thing many veterans don’t realize, though, is that the VA charges a funding fee of around 2% of the mortgage loan.  This is a fee charged by the VA and does not go towards the principal of the loan.  This fee can be rolled into the amount of the loan, and will be waived for certain disabled veterans.

Since not everyone is a veteran, there are other loan programs offered by lenders to make it possible to purchase a home with no money down.  Some lenders offer what is called an 80/20, which means that the borrower actually takes out two loans: a first mortgage for 80% of the loan and a second mortgage for 20% of the loan.  So instead of coming to the table with a 20% down payment the borrower instead is lent the money by the same financial institution granting the mortgage.  The reason that the loan is structured the way it is with an eighty percent loan and a twenty percent loan is because most lenders require private mortgage insurance when a borrower purchases a home with less than twenty percent down.  Private mortgage insurance (PMI) is basically foreclosure insurance, meaning the lender takes out insurance on the borrower and if the borrower fails to make the payments, leading to foreclosure, the lender recoups the losses through the PMI.  PMI is paid for monthly by the borrower as a portion of the loan, and the amount is not applied to the principal balance of the mortgage loan.  The 80/20 loan sidesteps the need for PMI.

Some lenders offer 100% financing, but these loans generally come with much higher interest rates and also will more than likely require PMI.  There are some lenders who will actually offer mortgage loans exceeding 100%, sometimes going up to 107% or higher.  A borrower should be extremely wary of any mortgage loan, which starts out with the borrower owing more than the property is worth.

Even if a borrower finds a loan program, which allows for no down payment it is important to remember that there are other initial costs involved in buying a home.  Earnest money is a sum of money, which is presented to the seller when submitting a bid to buy the home.  This money tells the seller that the borrower is serious.  If a seller receives two offers from two separate buyers with one offer coming with $200 in earnest money and the other offer coming with $2000, the second offer is more likely to receive the seller’s attention. 

There are also closing costs associated with purchasing a home, although in some cases a negotiation can be made for the seller to pay closing costs.  Some borrowers like to roll closing costs into the mortgage loan, but this situation results in the aforementioned negative equity situation where more money is owed on the mortgage than the home is worth.  Buyers should make every attempt at scraping together a down payment, even if it isn’t the desired 20%, as this will result in a better loan term and interest rate.

Related posts:

1. Tips on Creating a Savings Plan for your Home Down Payment
2. The Scoop on FHA Loans for First Time Home Buyers
3. A Few Tips On How To Find Best Home Loan Mortgage Refinance
4. Home Mortgages
5. The Many Factors of Escrow

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