Home Loan Guidance Topics

Energize the Value of Your Down Payment,
Make Your Savings Goals in "Cliffs"


The more you save for a downpayment, the less loan you'll need, and the more you'll save in interest. That much is obvious. Here are some not-so-obvious facts that can help you energize your savings to reduce not only interest, but also your interest rate on the entire loan balance.

The first big "cliff" is in loan fees and closing costs

Before your savings can go toward a downpayment, you will first have to pay for things like home inspection, appraisal, loan processing fees, real estate taxes, and other costs of home ownership. Average closing fees can vary from state to state, but can easily be several thousand dollars. You'll have to get over this "cliff" before any of your savings even goes toward a downpayment.

A secret to amplifying the power of your savings is in the LTV

Interest rates are often based on the level of the loan relative to the appraised value of the home you purchase. The LTV (Loan To Value) ratio is the percentage you get when you divide the loan balance by the home's appraised value.

Real estate markets can fluctuate over time and the value of your home can change. If you fail to repay your loan, the lender will have to sell your home to get its money back. If your loan is very close to the total value of the house, there is more risk that a changing home value could leave them with nothing to pay them back.

For high LTV ratios, the lender may charge more in interest and mortgage loan insurance to make up for the risk. Let's say you intend to buy a home worth $100,000 and have only $10,000 for a down payment, leaving $90,000 needed in a home mortgage loan. That means you have an LTV score of 90% for the loan of $90,000 and the value of the home of $100,000. Anything over 80% LTV is "higher risk."

Saving with the LTV in mind in 5% "cliffs"

When setting your savings goals, save based on the Loan To Value ratio and you will reduce your interest rate to the lowest possible levels or reduce your mortgage insurance to the point of it being zero. In fact, every 5% of downpayment generally reaches a lower risk level for many lenders, and thereby, a lower interest rate or possibly lower or no mortgage insurance.

For example, on a loan balance of $100,000, if you can make a downpayment of $19,900, you may pay an interest rate of 7 1/2% on the entire loan balance. However, if you can make a downpayment of $20,000, just one hundred dollars more, your LTV drops from 80.1% to 80%. At an 80% LTV, you may have an interest rate of 7%. A huge difference! That means that one hundred dollars in extra downpayment could save you $500 per year in the first year of interest alone. Anything slightly over 80% and you either have a higher interest rate or will be forced to pay mortgage insurance.

75% LTV's seem to get the lowest rates, with each increment of 5% increasing the rate or mortgage insurance. 80% LTV is better than 85%, 85% LTV is better than 90% and so on. Each 5% level could increase the interest rate, the insurance, or both.

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