Top Six Down Payment Mistakes
About to make a down payment on a home? Here's how to avoid the six most common down payment errors. Deciding how much of a down payment to make on a home is one of the most crucial steps in the mortgage process. The amount you pay up-front is a major factor in determining how much your monthly payments will be, which makes it a decision that could affect you for years to come. Here are six of the most common down payment mistakes home buyers make and advice on how to avoid making them yourself.

Mistake #1: Making too small a down payment
While lenders do offer mortgages with down payments of less than 20 percent of a home’s sale price, these loans require you to pay private mortgage insurance (PMI) -- an additional fee tacked on to your monthly payment to help protect the lender in case you should default on your loan.

In addition, low- and no-down-payment loans frequently carry higher interest rates and so can end up costing you considerably more over the life of your loan. Conversely, a down payment greater than 20 percent may earn you a more favorable interest rate if you have a less-than-stellar credit rating.

Mistake #2: Making too large a down payment
While common sense dictates that the more you pay up front, the better off you’ll be, that’s not always the case. One mistake first-time homebuyers sometimes make is using such a large portion of their savings for their down payment that they end up not having enough left over to cover closing costs and other expenditures for their new home.

Mistake #3: Not making a down payment at all
Some lenders offer mortgages that require no down payment but these loans can be risky. Paying no money down puts you in the position of having no equity in the home (i.e. you don’t own any part of it). Should the value of your home fall, there is the risk that you could end up owing more to the lender than your house is worth. This situation could also make it difficult to refinance your mortgage in the future.

A no-down-payment mortgage may be an effective strategy in certain situations. However, you need to be economically responsible and financially sound to be able to handle the inherent risks involved.

No-down-payment loans often come with a higher interest rate than loans with a conventional down payment. As a result, your monthly payments will be higher, leaving you with less money available for bills and emergencies.

Since you’ll be paying less than 20 percent of the home’s purchase price, you will also have to pay PMI or be required to take out a second loan (known as a “piggyback loan”). Each of these options increases the monthly cost of owning the home.

Mistake #4: Paying with unseasoned funds
In most cases, a down payment is a pretty substantial chunk of money, and not everyone has the ready cash to cover it. A gift from a friend or family member can help, but don’t think that just because you’ve come up with the full amount that you’re necessarily in the clear.

All funds -- whether they’re gifts from relatives, loans against an investment portfolio or your own savings -- that have been in your account for longer than two months are referred to as “seasoned,” meaning that they’re considered your money. If your bank statements indicate a large cash deposit that’s less than two months old, your lender will need to know where those funds came from and whether they’re gifts or loans. Gift-givers may be required to provide a letter to the lender indicating that they are in a financial position to offer the gift. Also, generally speaking, the larger your overall down payment amount, the less concerned the lender will be about where the money is coming from.

The lender wants assurances that the money you’re putting towards your down payment is actually “yours,” since it’s assumed that if you’re investing a significant portion of your own money into the down payment, you’re less likely to default on your loan.

Mistake #5: Neglecting to bring a cashier’s check to closing
Along with figuring out how much of a down payment you should make, you also need to ask your closing agent exactly how much you will be required to pay at closing. It’s not enough to simply bring your personal checkbook to closing. You will a cashier’s check to pay the amount of your down payment and your closing costs. Find out ahead of time exactly what the final total will be and obtain a cashier’s check for that amount.

Mistake #6: Incorrectly assessing your debt comfort level
No one knows better than you how much debt you can handle. Trust your instincts; if you’d rather pay as much as you can at the start and have the benefit of lower monthly payments, don’t let anyone dissuade you from that. The worst thing you can do is lock yourself into a mortgage that ends up costing you more per month than you can comfortably afford to spend.

Why Zero Down Payment Loans Can Be Risky
A down payment can help to reduce the risks of homeownership. Mortgages that don't require a down payment help many people purchase a home they otherwise wouldn't be able to afford. That's very good news. But no-down payment mortgages have additional risks that borrowers should understand before they obtain such financing.

What is a down payment?
A down payment is simply a percentage of the home's purchase price. For example, a 10-percent down payment on a $250,000 home would be $25,000. A down payment also can be expressed as a "loan-to-value ratio" or LTV. A 10-percent down payment would be equivalent to a "90-percent LTV."

The buyer's down payment becomes the new homeowner's initial "equity" in the home. (Equity is the value of the home minus what's owed on the mortgage.) For example, if you borrowed $180,000 to buy a $200,000 home, you would have $20,000 of equity. If you borrowed $200,000 to buy that same home, you would start out with zero equity in the home.

Zero money down can increase your loan costs
No-down payment mortgages are riskier for the lender since the borrower doesn't have any ownership stake in the home and could become "upside-down" if the value of the property dipped below the purchase price. That's why high-LTV loans typically are more costly than loans that require a larger down payment.

A down payment that's less than 20 percent of the home's purchase price triggers the need for either a second loan, called a "piggyback," or mortgage insurance, which protects the lender if the borrower defaults. Either option adds to the borrower's costs of owning the home.

Why having no equity can be risky
Homeowners who don’t have equity can't borrow against their home to remodel, add on or make repairs to the home or for such personal reasons as a family emergency, medical expenses or college tuition. Refinancing may be difficult as well.

Lack of equity can be a bigger problem if the homeowner needs to sell the home because if the value of the home has dipped, the sale price might not be enough to pay off the mortgage. If the value of the home stayed the same, a seller with no equity would have to pay the transaction costs out of his or her pocket. That's why soft housing markets make no-down payment loans more risky for lenders and borrowers.

How much to put down on a home
Unsure about how much you need to save in order to make a down payment on a home? There are several options. It’s not always easy to save up enough to make the traditional 20 percent down payment on a home. Fortunately, lenders today offer many low-down-payment mortgages. But when deciding how much to put down, you should consider the following:

Is 20 percent the standard down payment?
In order to qualify for a conventional mortgage, lenders usually require a minimum down payment of 20 percent. If you put down less than 20 percent, most lenders will require you buy Private Mortgage Insurance (PMI). This insurance typically costs about one-half of 1 percent of the purchase price of the home and protects the lender in the event that you should default on the loan. Your overall mortgage costs will therefore be less if you come up with 20 percent down and can avoid having to pay PMI.

What if I put down less than 20 percent?
If you can’t afford a 20 percent down payment, paying PMI may be your best option. And once you reach 22 percent equity in your home (or sometimes 20 percent equity with a good payment history), you can get your lender to cancel the insurance. An alternative is to apply for an 80/10/10 loan. It enables you to avoid PMI by financing half of the required 20 percent down payment with a second mortgage. The way it works is that 80 percent of the purchase price of a home is financed through a first mortgage, 10 percent through a second mortgage, with the final 10 percent coming from the down payment. Or you can apply for a government-insured FHA loan. Again, you will have to pay for insurance, but you may qualify with a down payment as little as 3 percent.

What about putting down no money at all?
It is possible to finance 100 percent of the purchase price of a home with a mortgage that requires no down payment at all. The disadvantage of this type of financing is that you are likely to be charged a higher interest rate than that of a standard mortgage. This means your monthly mortgage payment will be higher. Also, because you didn’t make the standard 20 percent down payment, you will have to pay PMI.

Let’s review the options
When deciding how much to put down on a home, it’s important to know what your options are so you can decide what works best for you.

Would you prefer getting instant equity in your home and lowering your monthly mortgage payment? Then putting down 20 percent may be best for you.

Are you unable to come up with a 20 percent down payment but want to avoid paying PMI? Then you may want to consider an 80/10/10.

Can you only come up with a 3 percent or 5 percent down payment and don’t want to wait to buy a home because you are concerned about rising house prices? Maybe a government-insured FHA loan would be a good answer.

Do you have no savings at all but are so eager to enter the real estate market immediately that you are willing to pay the extra costs involved in a no-money-down mortgage? Provided you are able to handle the required payments and are confident your financial situation will enable you to refinance for a mortgage with better terms in the future, it could be the way to go.

The important this is to evaluate your own situation carefully before you decide how much to put down on a home.

Low down payment? A piggyback loan or PMI can help
Sans a 20-percent down payment, you'll need to pay for either a second loan or lender's mortgage insurance. You’re ready to buy a home and you’ve decided to make a down payment that’s less than 20 percent of the purchase price. That decision triggers yet another one: Should you obtain a piggyback loan to create a 20-percent down payment or should you instead pay for mortgage insurance?

What is a piggyback loan?
"Piggyback" is an evocative description of a second loan for additional money that seemingly rides on the back of your first mortgage. Common piggybacks include traditional second mortgages, home equity loans and home equity lines of credit. Piggybacks can meet a variety of needs, one of which is the avoidance of mortgage insurance.

What is mortgage insurance?
Mortgage insurance is a financial product that protects your lender from the risk that you might not pay back the money you borrowed to purchase your home. Lenders typically require this insurance, which protects the lender from loss, if your down payment is less than 20 percent of the purchase price of your home. The smaller down payment means you have less equity at risk and thus, in the lender’s analysis, might be more likely to default on your mortgage.

Mortgage insurance can be purchased through government agencies or private-sector companies. The insurance is paid for monthly, usually as part of your mortgage payment.

In theory, mortgage insurance can be cancelled if the equity in your home grows to 20 percent of the home’s appraised value. In practice, however, lenders are loath to forgo the financial protection at your expense. You can ask your lender to cancel the insurance when your equity is more than 20 percent of the home’s value.

How a piggyback avoids PMI
A piggyback loan can eliminate the mortgage insurance requirement because the additional money from the second loan increases your down payment to 20 percent.

Suppose you purchased a $250,000 home and made a down payment of $25,000, or 10 percent. If you obtained a first mortgage of $225,000, the lender typically would require mortgage insurance. But if you obtained a first mortgage of $200,000 and a piggyback loan of $25,000, the separate $25,000 piece would increase your down payment to 20 percent and mortgage insurance wouldn’t be required. The catch is that the piggyback would be a second mortgage, and as such, it would have a higher interest rate than your first mortgage.

Pros and cons of piggyback approach
The key question when choosing between a piggyback loan or mortgage insurance is whether the higher rate of interest and additional loan origination costs for the piggyback would be more or less costly than the mortgage insurance.

The piggyback oftentimes may be the clear winner. But not always. If you intend to own your home only a few years, the mortgage insurance might be less expensive than the piggyback. Consider also that the piggyback could be paid off while mortgage insurance could be difficult to eliminate.

Your lender or mortgage broker should be able to explain the costs and tradeoffs to you, and some Web sites have calculators that can help you make the comparison between a piggyback and mortgage insurance. Research your options to figure out which choice is appropriate for your individual situation.

Pulling Together a Down Payment
When you venture into the housing market for the first time, you want to buy the best home you can afford. However, coming up with the usual 15 to 20 percent of your purchase price up front can be challenging.

Here are a few tips on pulling together your down payment:

• Bank your extra money. Any time you get a tax refund, bonus, commission or birthday check, put it into a separate savings account that you never touch.

• Live on one income. If you are in a couple, try living on one partner’s income while saving the other’s.

• Get rid of your second car. Or your cell phone. Or your cable service. Pare down your lifestyle so that you can add to your savings each month.

• Get a roommate. Change your lifestyle from solo to shared living. This will reduce your rent and allow you to save more.

• Pay off your debt. Get rid of debts with high interest rates, such as outstanding credit-card balances. This will ease the strain on your wallet and improve your credit rating. When your debts are paid off, try to save the money that would have gone to payments every month.

• Take a second (piggyback) mortgage. If you can’t get five percent or more together for your down payment, you may be able to get a piggyback loan to cover what your first mortgage doesn’t.

• Ask your lender about Fannie Mae or Freddie Mac products. Both of these Congress-chartered companies have flexible, low down-payment products that allow you to buy a home with down payments of zero to three percent.

• Ask your family. Parents or grandparents can be a great resource. They may be able to lend you money at a low interest rate.

• Find out about loan assistance programs. Government organizations like Veteran Affairs and the Federal Housing Administration offer programs that help people who don’t have large down payments obtain mortgage financing. Also, check with your state and local housing authorities to find out what they can offer.