When considering how much you can afford to pay for a condo, the down payment often looms large. And for good reason: it’s a lot of money. But what precisely is a down payment? And how much of one should you make?
First things first: a down payment is that amount of money you pay towards your condo upfront. In other words, this is the amount of the purchase that you are paying yourself – that you don’t need a loan for. You pay this amount directly to the seller and in return, you have that much equity in your home at the time of purchase. For example, if you purchased a condo for $100,000, with a twenty percent down payment, you would pay $20,000 directly to the seller, and then you would need to obtain an $80,000 loan to pay the seller the rest of the purchase price.
Down payment requirements vary depending on the type of loan you qualify for. If you are applying for a conventional mortgage, aim for 20% down. If you qualify for a FHA-guaranteed mortgage, you could get away with as little as 3.5% down. And if you are a military veteran, you could qualify for a VA-guaranteed mortgage that has even better terms, and requires no down payment from first-time buyers.
For more information about down payments, check out this post from Simple Dollar.
We’ll focus here on down payment considerations when using a traditional conventional mortgage.
The larger the down payment, the easier it is to get a loan. Traditionally, mortgage lenders have required that buyers put down at least twenty percent. If you put down 20% (or more) and you have decent credit, you’re likely to get a loan on fair terms, at the prevailing market rate.
In a seller’s real estate market, the buyer who can make the biggest down payment often gets the condo. The seller wants to make sure that the deal actually closes and, as discussed above, a bigger down payment makes you a far more attractive borrower to lenders.
Putting down less than twenty percent will cost you in the long run. When you put down a small amount, you’ll be required to purchase private mortgage insurance (PMI). The PMI is in place so that if you default on your loan, your mortgage lender will be compensated for the money it lost. Yes, that’s right: you personally receive no benefit for paying this insurance, other than the right to obtain a low-down-payment mortgage. And yet you’re stuck paying this extra fee every month, year after year.
If you put down a small amount, your interest rate will generally be higher. While this might seem like a minor issue, it can cost you literally tens of thousands of dollars over the lifetime of the loan. It may not seem fair, but it’s the mortgage company’s way of hedging its risk – if you have little invested upfront in your condo, you’re more likely to walk away should something go wrong. To balance out this risk, you have to pay more to obtain a loan.
The larger your down payment, the smaller your monthly mortgage payment. It’s simple math: say you stretch yourself and put down twenty-five percent on your condo purchase. As a result, you’ll need a correspondingly smaller loan – and so you’ll have less principal to pay off. Which means your monthly mortgage payment will be less – and you’ll pay less in interest over the life of the loan. In other words, you’re saving money by having money. Which means that if you can comfortably make a larger down payment, seriously consider it, particularly if interest rates are high at the time of purchase.
That said, don’t stretch yourself threadbare to make a larger down payment. Remember that when it comes time to close on your condo, there are more out-of-pocket expenses than just the money down. There’s paying your real-estate lawyer (yes, you need one), paying closing costs, paying transaction taxes (yes, your locality may have them), paying title transfer fees, etc. Bankrate.com has a handy chart that estimates the closing costs in your state. All told, estimate that you’ll end up spending an additional $4,000-$10,000 in transaction costs at closing. When the time comes, your mortgage lender will tell you the exact amount. Also, remember that as soon as you own the condo, you’ll need an emergency fund, in case something needs to be fixed. Budget at least $3,000-$4,000 for the emergency fund, if not more. So, when you’re deciding how much of a down payment you can afford, keep these additional expenses in mind.
Finally, remember that the equity itself doesn’t work on a percentage basis. Let’s say you actually end up buying a $100,000 condo with twenty percent down. Great, you own it! But… then the real estate market crashes and the value of your condo goes down to $70,000. That stinks, but you still have your twenty-percent share in the condo, right? No, actually. You still owe the mortgage lender $80,000 – you’re the one who takes the hit, not the bank. This is what it means to be “underwater” on your mortgage. On the upside, if the market value increases to $120,000, you still owe the bank $80,000 and you’d have doubled your equity (on paper) to $40,000. This is the benefit of using leverage, i.e. a mortgage loan, to make your purchase.
To put it simply, then, making a larger down payment allows you to get better terms, pay less in interest, and get more back when you sell. So, if you can make the twenty-percent down payment, you should do so, provided you have enough money left over to cover your other condo-related expenses. You may even consider putting down more than twenty percent, if that still leaves you with enough liquid assets to cover any upcoming large expenses (expected or otherwise) such as a new car, the birth of a child or the loss of a job.
With a condo purchase, the amount of down payment is between you and your lender. With a co-op purchase, however, there is a third party that has a say: the co-op’s board. A co-op’s bylaws may require you to put in a much higher down payment, perhaps 50%, and in some cases up to 100%. Now, why would they want that, if your bank deems you creditworthy at 20 percent or even less? They want to make sure that you have deep enough pockets to continue maintaining your apartment and paying the monthly fees, so your neighbors do not need to cover your share of building’s expenses.