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How will an appraisal affect my down payment?

The appraisal can have a significant impact on the amount of the down payment you will have to pay. In a seller's market, when buyers are many and sellers are few, property may be overpriced. You are free, of course, to pay any amount you wish for the property you buy. The problem arises with the loan you can get. For example, if the property you want to buy is appraised at $5,000 less than the price you have agreed to pay, your lender will want you to come up with a down payment that is $5,000 more than would be required if the property had appraised at the sale price.

Traditionally, a conventional (not government-insured or guaranteed) loan required a minimum 20% down payment. Government-insured or guaranteed loans required between 0% and 10% down, depending on the type of loan. Unfortunately, because of the changing standards involving real estate, fewer people have the 20% required down payment. However, there are ways to pay a smaller down payment.

What is private mortgage insurance (PMI)?

Lenders want to make loans at the lowest risk possible. With a 20% down payment, most lenders are comfortable with the risk level of the loan. To cover risks with down payments of less than 20%, private mortgage insurance was developed. Private mortgage insurance (PMI) insures the lender in the event that the foreclosure of a mortgage results in a sale that nets less than the balance owed on the loan. The cost of the insurance is paid by the borrower. For a loan with a down payment of less than 20%, you will have, as part of your monthly mortgage payment, an additional payment for PMI. The insurance does not cover the entire loan amount — only a small percentage. So, if you have only 10% to put down, the lender requires you to buy PMI to cover the other 10%. If the lender takes a loss, the insurer will cover that loss up to 10% of the amount of the loan.

Theoretically, the lender's risk is the same as if it made an 80% loan. As a practical matter, though, the lender's risk is greater, since borrowers who put 10% down are more likely to default than borrowers who put 20% down. The more you put down, the better chance you will get the most favorable interest rate for a loan and have to pay less in PMI.

The rates you will pay for PMI vary, based on the percent covered and the borrower's credit score. Borrowers who put down 5% pay more than those who put down 15%. This makes sense because more insurance is required. It also makes sense that a higher down payment means a lower risk of default.

The lender may have a choice of how much insurance it requires. The lender may buy insurance to cover 30% of the loan, rather than 20%. This will cost more. If you are getting PMI, ask if the lender is getting the minimum insurance. If you have good credit and good income-to-debt ratios, you should question why the extra insurance is necessary. At the time you apply for the loan, you also want to ask about cancellation of the PMI. Once you have paid on the loan to a point that PMI should no longer be required, you should stop paying for it or get a refund if you paid the total up-front. Laws now require a lender to cancel PMI when the loan-to-value ratio reaches 78% of the value of the property at the time when the loan was made if cancellation is not requested by the borrower, and at 80% if the borrower makes a request. Ask about cancellation before taking a loan and always contact your lender when the loan-to-value ratio reaches 80% to have it canceled.

Many people hate having to pay PMI. There are ways to avoid PMI using different types of loans that will be discussed later. One way to increase your down payment and lower or eliminate PMI is through a gift.

From the Expert

As a general breakdown on what the cost of PMI will be, you can expect to pay between .75% to 1.5% of the loan amount for PMI.

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