How to come up with a down payment

Down-payment assistance programs offered by private organizations -- Nehemiah and AmeriDream are two of the largest -- convert money contributed by the seller into the buyer's down payment.

"They are using the seller's equity to fund a grant, which allows the buyer to buy with no money down," says Peter Thompson, a senior loan officer with Professional Mortgage Partners in Downers Grove, Ill.

These programs "serve a need for people who struggle to save a down payment, if the seller is motivated to contribute," Gwizdz says. But these programs are not without controversy. The down payment is of value only if the homebuyer can afford the monthly payments, Gwizdz says. And whether someone who didn't have the discipline to save a down payment would have the discipline to make the payments may be questionable.

The FHA has tried, so far unsuccessfully, to ban the use of private down-payment programs in conjunction with FHA loans because FHA-insured loans using these programs have been shown to have a significantly higher incidence of default and foreclosure than loans not using such assistance, according to an FHA study.

"FHA loans made to borrowers relying on seller-funded down-payment assistance go to foreclosure at three times the rate of loans made to borrowers who make their own down payments," FHA Commissioner Brian Montgomery said in a May speech.

Nehemiah CEO Scott Syphax, in a June 9 statement, said the government shouldn't restrict access to homeownership.

Down payment or closing costs?

Should homebuyers who have limited funds allocate more money toward their down payment or set aside some share of the total for closing costs?

The simple answer is that the down payment should be the priority, up to at least 5% (or 3% for an FHA-insured loan) of the home's purchase price. Thompson explains why: "It doesn't matter if they have the money for closing costs if we can't show (the lender) that they have the money for the down payment."

If you've saved enough for a down payment but not closing costs, here are some options:

• Ask the seller to pick up the tab.

• Pay a higher interest rate in exchange for lender-paid closing costs.

• Wait to buy a home until you've saved more money.

If you want the seller to pay the costs, you should discuss that concession upfront before you sign a purchase contract, because payment of costs is a negotiable term that affects the seller's net proceeds from the transaction, Thompson explains.

Borrowers can reduce or even eliminate their closing costs by paying a higher interest rate on their mortgage, Craine adds. This sophisticated strategy should be discussed with your loan officer, but the basic rule of thumb is that an additional 1/8% higher interest rate will net a credit against closing costs equal to 1/2% of the loan amount. For example, an additional 3/4% in interest might eliminate closing costs of 3%. The catch is that as your credit gets larger, it takes a bigger interest rate jump to achieve the same amount of savings.

"Instead of your total costs being 3% at one end of the spectrum and zero at the other end with a 3/4% higher interest rate, you could compromise on whatever combination of closing costs and interest rate you want," Craine says.

This article was reported and written by Marcie Geffner for Bankrate.com.

Published Aug. 26, 2008

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