What Is the Down Payment?

January 21, 2002, Revised November 24, 2006, February 23, 2007, August 15, 2010, Reviewed April 7, 2011

The down payment on a home mortgage is the lower of sale price and appraised value less the loan amount. It is not the same as the borrower's cash outlay if some of that outlay is used for settlement costs. Financing settlement costs does not affect the down payment. Land can be part or all of the down payment.

Down Payment Is Not the Same as Cash Investment

"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%.

Financing Settlement Costs

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.

Appraisal Versus Sale Price

“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. Read Avoiding Taxes on a Gift of Equity.

Land as the Down Payment

“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 the down payment.

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%.

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