Home Loan Down Payment, Points, Mortgage Insurance, and Other Closing Costs

Calculator, pen, and tiny homes on mortgage loan closing documents.Another issue to explore before applying for a home loan is which factors influence your upfront costs and monthly mortgage payments. This includes the down payment, mortgage insurance, and points. It is crucial to understand how all of these financial components work before deciding on a home loan.

What is Your Down Payment?

Your down payment will ultimately influence the interest rate offered by the mortgage lender, as well as your ongoing monthly payments.

Down Payment Requirements

In the past, the standard down payment was 20% of the home’s purchase price. This in turn would mean the lender was providing 80% of the purchase price as a loan, a level most felt comfortable at. Most lenders reasoned that if they have to take the house back, they should be able to sell it for at least 80% of what the borrower purchased it for and recoup their investment.

However, in recent years the down payment requirement had come down significantly. It was not unheard of in peak times (2006 – 2007) that lenders would even go up to no-money-down mortgages. However, since the housing collapse and subprime crisis, some lenders are back to requiring down payments in the 10 to 20% range.

Currently, without a special incentive program offered by a specific bank, credit union, or other mortgage lender, FHA loans typically require a 3.5% minimum down payment and conventional loans require a minimum of 3% down for people with an ideal credit history and score. USDA and VA home loans don’t typically require a down payment.

Paying the Minimum Down is Not Always Best for Everyone

An important point to keep in mind is that just because a lender only requires three percent down, it does not automatically make that the best option for you. Oftentimes a lender is willing to overlook a low credit score or offer a more favorable interest rate if the more the borrower is willing to put more money down.

Even a small change in the rate offered can have a substantial impact over the life of the loan, so it is important to pursue all options offered by the mortgage lender. Discuss the outcomes of bringing a higher down payment to the table and buying down the interest rate.

Mortgage Insurance

If you do decide to put less than 20% down when purchasing the property using a conventional loan the lender will require a guarantee that they can recoup their investment in the event of a default. This guarantee will come in the form of mortgage insurance, often referred to as private mortgage insurance or PMI. With PMI, the borrower is required to pay a premium each month or cover the entire premium upfront, to help protect the lender against default.

In the case where the borrower is unable to pay the mortgage, PMI ensures the lender will still be paid in full. Most often, this premium is included in the monthly payment the borrower makes and it is arranged by the lender at the time a mortgage is approved.

Consider Paying More Down to Alleviate the Insurance Cost

Private mortgage insurance can increase your monthly payment by a few hundred dollars depending on the amount borrowed. This expense does not benefit you as the borrower in any way long-term, but it does allow you to get a home loan without an even more significant initial out-of-pocket expense.

However, this cost remains with you and your mortgage for an extended period of time, depending on your particular financial situation. The upfront cost savings it allows may not be worth it in the end. For this reason, it is crucial to evaluate your ability to incur this additional monthly cost when getting a mortgage loan and the long-term effect it will have on the total amount you pay for real estate.

Understanding Mortgage Points

An option often presented by lenders is the concept of points and the various connections between points and interest rates. A point is a fee which equals 1% of the loan amount. For instance, on a $200,000 mortgage, 1 point would be equal to $2,000, and 2 points would be $4,000. Typically, the lender has two variations of points:

Origination Fee

The first, known as an origination fee, is a fee charged by the lender to cover the costs of securing the loan. This fee is usually quoted in terms of points.

Discount Points

The second, known as discount points, is prepaid interest on the loan. The more points the borrower is willing to pay upfront, the lower the annual percentage rate (APR) of their mortgage loan will be allowing them to pay less money on interest over the life of the loan.

Although discount points add upfront costs to the mortgage at closing, the reduction in interest rate can, over the course of the loan, more than make up for this fee.

An important piece to keep in mind when debating whether to buy discount points is that the positive impact of paying upfront points is realized over the course of the loan, and not quickly. For this reason, you must be fairly certain you’ll remain in that house for an extended length; otherwise, points may not prove financially beneficial for you.

Up Next, The Mortgage Application Process

Next, we cover the required documentation lenders expect you to provide with your application, questions the lender will ask you, and important questions to ask your lender. Here’s what to expect when you apply for a home mortgage loan.

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Posted on February 5, 2021 by in Mortgage Lending

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