When you see a property you like, do you immediately run the down payment math? The 20 percent rule of thumb guides many home mortgage loans, but it’s not the only option you have. Below, we show you how your potential down payment can affect the type of loan you take out, and how much you pay in the long run.
First, let’s take a look at the difference between loans backed by the government, and conventional loans.
When you take out a home mortgage loan, your lender will assess your loan-to-value (LTV) ratio. This is the comparison between the value of your loan and the value of your home.
For example, if you plan to buy a $200,000 home in Eagan, and have saved $40,000, then you have a 20 percent down payment. In this case, the loan-to-value ratio is 80 percent.
So, what do loan-to-value ratios have to do with getting a mortgage? In short, the lower your LTV ratio, the less risk for the lender. A borrower with an 80 percent LTV ratio would be considered less risky to a lender than one with a 95 percent LTV ratio because they have more equity in their home from the start of the loan.
Conventional loans are not backed by the government and generally require an LTV ratio of 80 percent. Borrowers with less than 20 percent down may be approved for a conventional loan if they agree to pay private mortgage insurance (PMI), a monthly payment designed to protect the lender against default until the borrower reaches 20 percent equity.
When you hear someone mention that 20 percent is required to get a mortgage, they are likely talking about securing a conventional loan.
What if you want that Eagan home, but don’t have the 20 percent down? In that case, you may want to turn to a government-backed loan.
FHA loans, which are backed by the Federal Housing Administration, can require as little as 3.5 percent down. In the case of the Eagan home, a borrower may be able to secure an FHA loan with as little as $7,000 down, which would have an LTV ratio of 96.5 percent. That’s considered risky for the government, which is acting as the lender.
To lessen the risk, borrowers with FHA loans are also required to pay for private mortgage insurance (PMI). Private mortgage insurance costs can vary, so it’s critical that you speak with your lender to determine your total monthly cost (between mortgage payment, PMI, and other recurring costs like homeowners insurance and maintenance) to see what’s feasible for you and your family.
VA loans are backed by the Department of Veterans Affairs. VA loans are the only type of loan that do not require a down payment or private mortgage insurance. To see if you’re eligible for a VA loan, see the eligibility guidelines.
Get the help you need
In sum, finding and securing a home mortgage loan is a personal and private matter that requires the help of a home mortgage consultant. Contact us today to be put in touch with a mortgage consultant who can help you get started on the path to homeownership.