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January 21, 2002
"My
understanding is that if a home buyer puts 20% down, he doesn�t have to
purchase mortgage insurance. I put
20% down -- $48,000 on a $240,000 home purchase � but I�m told that I do
have to buy mortgage insurance because I elected to finance $6,000 in settlement
costs, making the loan $198,000 instead of $192,000.
How come?�
You
are confusing the amount of cash you put into the transaction with the down
payment. The down payment is
smaller because of settlement costs.
In
dollars, the down payment is the difference between property value and loan
amount. In your case, value of
$240,000 less the loan of $198,000 leaves just $42,000 for the down payment.
That is 17.5% of property value, so you must purchase mortgage insurance.
In
percent, the down payment is also 1 minus the LTV� the ratio of loan to value.
In your case, the loan of $198,000 is 82.5% of the value of $240,000, and
1 - .825 is .175, or 17.5%.
On
a purchase transaction, �financing settlement costs� has no meaning because
it amounts to exactly the same thing as paying the settlement costs in cash, and
borrowing a larger part of the sale price.
If you paid the $6,000 in cash out of your $48,000, you would have
required the same loan of $198,000.
To
avoid this type of confusion, mortgage insurance requirements and many
underwriting rules are based on the LTV rather than the down payment.
Mortgage insurance is required when the LTV is higher than 80%.
This is the same as requiring insurance when the down payment is less
than 20%, but it avoids any confusion about what constitutes a down payment.
On
a refinance transaction, financing settlement costs is meaningful because it
results in a larger loan than would have been the case otherwise. For example, if several years down the road when your loan
balance is $190,000 you decide to refinance, the new loan could be for $190,000,
or it could be for $190,000 plus the settlement costs.
But note that whether or not you have to pay for mortgage insurance on
the new loan will depend on whether the new loan amount, inclusive of settlement
costs or not, is more or less than 80% of property value at that time.
�I managed
to buy a house for $200,000 that has been appraised for $245,000.
Can the difference of $45,000 be counted as my down payment?�
No.
The rule is that the property value used in determining the down payment
and the LTV is the sale price or appraised value, whichever
is lower. The
only exception to this is when the seller provides a gift of equity to the
buyer, who is almost always a family member.
In this case, the lender recognizes that the house is being priced below
market and will accept the appraisal as the value. Most lenders in such cases will require two appraisals, and
they will take the lower of the two.
�We own a
piece of land and plan to build a house on it.
In this case, can we use the land as the down payment?�
Yes.
If you have held the land for awhile, the lender will appraise the
completed house on your lot, and the difference between the appraisal and the
cost of construction will be viewed as your contribution.
For
example, if the builder charges you $160,000 for the house and the appraisal
comes in at $200,000, the land is assumed to be worth $40,000. A loan of $160,000 in this case would have a down payment of
20%, or an LTV of 80%.
If
you purchased the land recently, however, the lender will not value it for more
than you paid. If you paid only
$30,000, for example, the lender will value it at $30,000, and your down payment
will only be 15.8%.
Copyright
Jack Guttentag 2002
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