Everyone’s dream is to own a house. Be it a bungalow, duplex, storey building etc. They are all houses people wish to have.
However, most prospective house owners do not gather as much money needed for the purchase of the house. Hence, the need for a down-payment.
A down-payment is a fraction of the total amount of an expensive item (a house in this case) which is initially paid when the item is bought on credit. It is also known as an upfront partial payment.
So, if you want to purchase a house and do not have up to the price tag of the house, you can decide to make a down-payment and pay the remaining amount later.
Usually, some house sellers accept down-payment from buyers and allow them to start using the house pending the tome they will pay up the earlier stated amount.
For example, if you want to purchase a house worth $100million, your house seller might require you make a deposit of at least 20%, which is $20million in this cas.
You as the buyer might decide to purchase your home making use of your personal savings or using a loan. Lenders who give out loans to house buyers are referred to as mortgage lenders.
If you are to make a down-payment, your mortgage lender will provide a loan for the outstanding balance, but will not provide for the upfront. The buyer, himself, is required to source for the down-payment from other places asides mortgage loans.
In addition, before mortgage lenders can provide you a loan after you ghav made a down-payment, you will be asked for the Loan To Value ratio (LTV). The Loan To Value ratio is the percentage of the house value when the down-payment has been deducted.
In the scenario of making a down-payment of $20million for a $100million home, the outstanding balance which is $80million will be be granted to the buyer as the mortgage loan. Hence, Loan To Value ratio here is 80% and that means the buyer will receive a loan of $80million from his mortgage lender.
You, as the borrower might be wondering why exactly does your mortgage lender, requires you make a down-payment from your own pocket before you are granted a mortgage loan. See the next subheading for reasons.
Why does my Mortgage require down-payment from my own pocket?
Firstly, down-payments serve as a guarantee for mortgage lenders that the borrower’s are capable of paying back the mortgages and never defaulting the terms and conditions of the loan agreement. This helps reduce the risk encountered by the lenders.
Also, when borrowers make a down-payment, they become very disciplined on repaying the mortgage. With this, they learn to budget ahead of their due date.
However, there are very few mortgage lenders who require zero down-payment on mortgage loans. These kind of mortgage lenders accept other things in form of down-payment. I will explain more about this later in this article.
Let us assume, you do not know other sour ed to make a down-payment on your house, we will show you other ways by which you can get funds for your down-payment.
Sources of Down-payment.
Firstly, most house buyers do sell off their old houses before going ahead to purchase a new one. The proceedings made from the sale of the previous house can be used from the sale of the previous house can be used as a funding source for your down-payment.
For example, if you sold your former house for $3million, and you want to purchase a new house which costs $10million, you can decide to make a down-payment for the new house with the $3million. Then, your mortgage lender can give you a loan of $7million to pay off the outstanding balance.
Secondly, you as the buyer can use your personal savings as a down-payment for your new house purchase. This can be from your salary savings or business returns. Also, you can sell off your valuable assets like your land, car, or company.
However, if any of the above listed sources are not available, you could seek help from your friends or family members. In fact, borrowing from friends and families is easier and better, because you will not be charged any interest on the loan due to familiarity.
Types of Down-payments.
There are various kinds of down payment loans which depend mainly on the percentage paid by the buyer who is a borrower at the same time. They include
- VA loans where borrowers can get a loan as high as 100%LTV. In this case, the borrowers do not make any form of down-payment, as the mortgage lender takes full responsibility of the whole amount. This also applies to USDA borrowers.
- FHA loans require borrowers to make a down-payment of at least 10% of the house value. For example, if the house is priced as $1,000, FHA lenders will ask you to make an upfront partial payment of $100.
Can you use collateral as a down-payment for a house?
Here comes the big question which has brought you here. Not everyone ready to take a mortgage loan has the ability to pay an upfront or a down-payment, and begins to source for other options which can act as an alternative for a down-payment.
Remember, I mentioned earlier that most mortgage lenders require that you make a down-payment on your mortgage loan. However, there are few lenders that accept other forms of down-payment in place of cash.
This replacement stands as a collateral. Just a quick reminder, a collateral is used as an insurance for your lender, when you borrow money. Suppose, you do not meet your own terms and conditions, your collateral can be useful for your lender to fall back on.
If anything happens, the lender has the right to take over whatever you have used as collateral. A number of valuables can be used as a collateral. For example, you can use your car, house or they assets accepted by your lender as collateral. In as much as the value of the collateral is greater than or equal to the down-payment.
However, if you are using collateral as your down-payment, it means that your mortgage lender will have to pay the house value amount in full. Let me state an example for better understanding.
If you want to purchase a home worth $100,000 and you are to make a down-payment of 10% which is $10,000, you can decide to use your car which worths $15,000, as collateral.
The mortgage lender keeps track of your collateral and gives you a loan worth $100,000 to settle your debt. You will then be required to pay back the $100,000 to the mortgage lender installmentally at a fixed rate.
In case you default to pay as at when due, your lender takes over your collateral (car), the house you have purchased with the loan. These two assets now become the property of the money lenders until you pay back your loan.
In conclusion, using a collateral for your house down-payment has its own advantages and disadvantages. Talking about its advantages, you can get a loan to purchase your own house even without paying an upfront. As long as you have a property which must at lest be equal in value to the down-payment amount.
Also, when you make use of a collateral as a down-payment, you can use your money for other things like emergencies and other unplanned events. Instead of using your whole savings as down-payment, you can just continue saving it, invest it or use it purchase something else. This kind of mortgage loan is recommended for people who need capital for business purposes. If you have sold your previous house, keep the money where it will grow and use collateral in place of a down-payment for a mortgage loan. When it yields more money, you can use the returns to start paying back your mortgage lender. This way, nobody looses.
On the other hand, it is not 100% reliable to use a collateral as a down-payment for your house. It could be risky for both the borrower and the mortgage lender.
For the mortgage lender, if your client uses a collateral to take a loan, it is not guaranteed that he/she will be able to pay back at the right time. There are chances that the borrower might default on his repayment.
Likewise, if you are the borrower, it is not also advisable to use a collateral as a down-payment. If there are no means to repay your loan, you might run into a huge debt and lose your house and your collateral as well.
Have it at the back of your mind that using a collateral as down-payment for your house is not suitable for everyone as we all are under different circumstances. If you feel you are comfortable with your mortgage lender aggrement, you can sign the loan, but if the conditions do not suit, you can just walk away. Every piece you have read here is only for informational purposes and does not serve as a persuasion.