The end of the 0% down payment

By Liz Pulliam Weston

Mortgage lending has changed dramatically in so many ways, but one of the most critical developments for homebuyers has to do with down payments.

Now you need one.

You didn't at the peak of the mortgage lending boom. Lenders were delighted to loan you the full purchase price of a house. Waiting to build up your savings seemed foolish because ever-rising home values in many cities could quickly price you out of desirable areas.

Today, as foreclosures skyrocket and home values tumble, lenders are demanding that borrowers have skin in the game, as I wrote in "Need a loan? Borrow like it's 1975." Though you can buy a house with as little as 3% down, a bigger stockpile can lower your payments and increase your mortgage options.

Here's how to figure out how much you need and where to get it.

To start, there are three break points you need to know: 3%, 10% and 20%.

The 3% option

Borrowers who can scrape together just 3% of the purchase price (3.5% starting Jan. 1) basically have one choice, but it's not an awful one: Federal Housing Administration loans. These loans:

• Have somewhat higher rates. Recently the FHA rate for someone with good credit was 6.25%, said Matt Hackett, an underwriting manager for mortgage lender Equity Now, compared with 5.625% for a conventional loan with a 10% down payment.

• Require mortgage insurance. FHA loans require an insurance premium worth 1.75% of the amount borrowed, which is typically rolled into the loan, plus an annual 0.55% premium that adds about $92 to the monthly cost of a $200,000 loan, for a total payment of $1,326.67, excluding property taxes and home insurance.

• Are somewhat credit-sensitive. The lower your scores, the higher your rate, with those in the 580 to 620 bracket paying rates about 1 percentage point higher than those with scores higher than 720. With a conventional loan, however, your rate could be 2 percentage points higher, or more, with poor scores. That's why the lower your credit score, the higher the chances the FHA will be your best option, given other lenders' intolerance for risk.

Besides the extra costs of an FHA loan, the big problem with putting down 3% is that you're basically "underwater" the minute you buy the home.

Selling costs typically eat at least 6% of a home's value, so you wouldn't be able to sell the home for what you owed -- at least not until home prices start rising again, which isn't going to happen soon. (Some optimistic economists predict we'll hit the bottom for real-estate prices next year, while others believe recovery won't begin until 2010 or beyond.)

Owing more on your home than it's worth is no big deal if you can wait it out. But if you lose your job or otherwise have to sell, you'll have three bad options: Come up with extra cash to pay the lender, try to get the lender to accept less than it's owed in a short sale, or submit to foreclosure.

The 10% plan

If you can scrape up at least 10% of a home's purchase price, your options improve quite a bit, said Cameron Findlay, the chief economist for mortgage quote site LendingTree.

You'll find more lenders competing for your business, which can mean lower rates and fees, Findlay said.

You also start the game with at least a little equity. Yes, that could be wiped out if real estate in your area continues to tumble, but at least that wouldn't happen as fast as it would had you bought with less money down.

You'll still have to pay private mortgage insurance because you aren't putting 20% down. The annual premium of 0.52% would add $87 to your monthly payment for a $200,000 loan, for a total of $1,217.81.

The 20% solution

If you can pay a fifth of a home's purchase price, you should be able to ride out the real-estate swoon without losing all your equity.

But a bigger down payment doesn't translate into a lower interest rate. Recent rates on conventional loans with a 20% down payment were 6.125%, half a percentage point higher than those with a 10% down. But you won't have to pay private mortgage insurance, so your monthly payment to borrow $200,000 will be about the same as with a 10% down, or $1,215.22. (I'm assuming you'd use the bigger down payment to buy more house. If you instead used the payment to reduce the amount you borrowed to $180,000, your payment would be $1,093.70.)

A 10% down payment gets a slightly lower rate because lenders are somewhat better protected with private mortgage insurance, Hackett said. PMI protects lenders against losses down to 75% of a home's value.

You may not always have much of a choice about how big a down payment to make. If you're seeking a so-called jumbo loan, for example, lenders may demand down payments of 30% or even more, said Michael Moskowitz, Equity Now's president. (Any loan above a certain dollar amount can't be sold to mortgage agencies Fannie Mae and Freddie Mac. The limit varies by region, but as of Jan. 1 any loan over $625,500 will be considered a jumbo.)

Continued: Get out those magic beans

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