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%.
January 21, 2002
