Whether or not to buy a home is, for many, the single most important financial decision in their life. The second is how much to put down on a home loan. Your down payment plays an important part in the home loan approval process.
The down payment influences:
- Loan-to-value ratio,
- Private mortgage insurance,
- Debt-to-income ratio,
- Housing expense ratio, and
- Interest Rate.
Loan-to-Value Ratio: This is the percentage a financial institution lends compared to the value of the property. If a home’s market value is $100,000, and one borrows $80,000 to purchase it, the loan-to-value ratio is 80 percent. While special loan programs exist, in today’s marketplace, one should expect to need a down payment of 20 percent for loan approval.
Private mortgage insurance: This is an insurance policy paid by the borrower. In case the homeowner defaults on their mortgage payments, and the financial institution is unable to recover costs through the foreclosure process, private mortgage insurance offsets the lender’s losses. You can avoid paying this cost with a 20 percent down payment.
Debt-to-income ratio: One’s debt-to-income is the percentage of your monthly income that goes toward paying their debt. This includes credit cards, car payments, child support, legal judgements, and more. One’s potential housing expenses are also included.
Each financial institution, and depending on the type of loan, has their own requirements. However, exceeding this ratio will negatively impact loan approval. The down payment affects the payment and, therefore, one’s debt-to-income.
Housing expense ratio: This is sometimes referred to as the payment-to-income ratio. It is the percentage of your monthly income going towards housing: mortgage payment (principal and interest), private mortgage insurance, homeowner insurance, property taxes, et al. The housing expense ratio becomes difficult to understand for some home buyers.
An example is a bank requiring no more than 33 percent of one’s monthly income going toward housing expenses. However, these expenses are added into one’s debt-to-income calculation. The percentage limit decreases with the more debt one owes. As with the overall debt-to-income, your down payment lowers your loan payment and affects the housing expense ratio.
Interest rate: The interest rate represents your cost to borrow the funds for the home purchase. Your down payment is your initial investment. It creates instant equity in the property and lessens the lender’s risk. For this reason, many financial institutions will give a better interest rate with a higher down payment.
If you would like more information or to talk more about how much to put down on a home, please contact us.