- The Washington Times - Thursday, June 23, 2005

We are in the early stages of buying a new home. We have spoken to a

couple of real estate agents who have run some numbers.

It seems that we are just short of cash for a 10 percent down payment. As I understand it, the rates are higher if we put less than 10 percent down. Our purchase price range is $400,000, and we have almost $44,000 in cash. This is not enough to cover a 10 percent down payment and closing costs.

Do you recommend that I borrow against my 401(k) retirement plan at work, or should I settle with a lower down payment?

A: Before I make any recommendation, let’s establish your priorities and run some numbers.

First, let’s examine the difference in payment between 95 percent financing and 90 percent financing. In order to avoid private mortgage insurance (PMI), which is a monthly fee charged if the first trust exceeds 80 percent, you will want to split the financing into two loans. Using a purchase price of $400,000, your first trust will be equal to $320,000, which represents 80 percent.

Using a market rate of about 5.50 percent for a 30-year fixed rate, the principal and interest (P&I) payment equals $1,817. Adding a 10 percent second trust in the amount of $40,000 at a rate of about 6.75 percent will result in a P&I payment of $259.

Add an estimated payment for real estate taxes and hazard insurance of $325, and we come up with a total principal, interest, taxes and insurance (PITI) payment of $2,401. This scenario is often called an “80-10-10” program — an 80 percent first trust, a 10 percent second trust, and a 10 percent down payment.

Now let’s examine numbers with only 5 percent down, or an 80-15-5 program. The first trust balance would stay at 80 percent, but it’s possible that the rate could be slightly higher as a result of a lower down payment. Let’s assume the rate bumps to 5.625 percent. On a loan amount of $320,000, the P&I payment is $1,842.

The second trust balance increases to $60,000. Depending upon the lender, the rate could be higher because of the lower down payment, but I have also seen second trust programs that have lower rates as the loan amount increases.

Let’s just use the same rate for this example. At 6.75 percent, the P&I would increase to $389 per month. Add $325 for taxes and insurance and we have a PITI of $2,556. The difference in monthly payment between 90 and 95 percent financing is $155 per month.

Let’s look at the difference in cash outlay. A 10 percent down payment equals $40,000. A 5 percent down payment equals $20,000. Closing costs and escrow deposits can vary greatly depending upon where you are buying. Assuming Virginia, this number might total something close to $9,000.

Now we have to set your priorities. With 10 percent down, you will need about $49,000. With 5 percent down, you’ll only need about $29,000. But your mortgage payment will be higher by $155 per month.

First, you have to determine whether the increased payment is affordable in your personal budget. If so, you need to make sure that you qualify for the higher payment. If a lender gives you a “thumbs up,” you need to ask yourself if putting down 5 percent is what you want to do.

The additional $155 increases your total monthly payment by only a little more than 7 percent. Yet you will be able to retain $20,000 for your savings account. If you take into consideration the additional tax savings due to the additional interest paid, the difference in monthly payment shrinks even more. You may want to abandon the idea of a 10 percent down payment, pay the extra $155 every month and keep some money in the bank.

However, if you still feel that a 10 percent down payment is best for you, there are some things to look at. Borrowing against a retirement plan is certainly a possibility.

Remember, though, that such a loan still carries a monthly payment, so you need to factor it into your budget.

Another option would be to negotiate a closing cost contribution from the seller. For example, instead of agreeing on a purchase price of $400,000, agree to pay $409,000 and have the seller pay $9,000 toward your closing costs. You would then only need the down payment of $40,900 at settlement. Your total payment would increase by less than $50 per month.

This is a creative and very workable solution, but there are a couple of potential problems. First, the property would have to appraise to the new purchase price. Second, although such a scenario doesn’t change the seller’s net proceeds, it may make it more difficult for a seller to accept your offer.

We are still in a market that heavily favors sellers, and a closing cost contribution, even if rolled into the purchase price, could cause a snag.

Henry Savage is president of PMC Mortgage in Alexandria. Contact him by

e-mail ([email protected]).

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