Is 30 The New 20?

How much do we need to put down?

One of the first questions that crosses a prospective homebuyer’s mind, save for cash buyers. Traditionally 20% down has been a rule of thumb. By reaching this threshold, borrowers generally receive favorable interest rates, avoid having to pay private mortgage insurance (PMI), and are usually perceived by lenders and sellers as strong on paper when making an offer on a home.

But if 20% down is the benchmark for a strong borrower and hence a strong buyer, why is it that in the Bay Area we often hear that 20% isn’t enough? Common sense begs the question:

Why should the seller care about the buyer’s financing? At the end of the day, the seller will walk away with the same amount of money, sometimes even more, by accepting a 20% down offer versus a 50% down offer or even an all-cash offer.

Turns out that sellers aren’t always looking for the highest offer. After all, even the highest offer is not worth much if the seller does not believe the offer will close. Sellers are usually looking for the highest offer that also has the highest probability of closing smoothly. This means in addition to the offer price, sellers will generally favor offers that include fewer “outs” for the buyer, i.e. contingencies, and favor buyers with loans that are less likely to fall apart during the sale (or cash offers where there is no loan risk). But if you are preapproved with a reputable lender, how can your loan still far apart?

Well, after an offer is accepted your lender will order an independent appraisal to confirm the value of the purchased property.  If the appraisal is short of the purchase price, the bank will only lend you the agreed upon % of the appraised value. For example, if you want to put 20% down on a $1M property ($800K loan/$200K down), but the appraisal comes in at $950K, the bank may only lend you 80% of the appraised value or $760K and you will need to put $240K down. In this case, the appraisal gap may effectively require you to put 24% of the purchase price down on an 80/20 loan. If you insisted on only putting $200K down, the loan would be $800K or 84% of the appraised value of $950K, and your lender may require PMI, charge a higher interest rate, or can flat out deny you the loan altogether.

As a buyer, you can protect yourself from this situation by:

• Attempting to renegotiate the price; or
• Holding extra cash in reserve to pay a higher down payment; or
• Including an appraisal contingency in your offer allowing you to back out if the property appraises for less than the offer price.

Sellers may protect themselves by:

• Asking you to waive the appraisal contingency (you may need to increase your down payment); or
• Eliminating your offer from the running in favor of an offer that is less risky to the seller.

Therefore in a multiple-offer scenario a lower down payment offer may be less competitive because if it comes with an appraisal contingency, the seller may regard the offer as risky. The lower down payment buyer may offer a higher price to compensate for the risk, but if the property does not appraise at the purchase price, what good is the higher price to the seller once the buyer backs out or can no longer get a loan? The higher the appraisal risk, the more the seller tends to favor buyers that can cover an appraisal gap, i.e. higher down payments. If the seller is confident the property will appraise close to the purchase price, a lower down payment may not be a disadvantage as long as the other terms in the offer are still competitive.

This is why in our hot Bay Area market, 25%, 30%, or even larger down payments have become more common, though offers and loans still come in all different shapes and sizes. A higher down payment may give you confidence in waiving the appraisal contingency, signaling to the seller you are both qualified to and highly committed in purchasing the property. As a seller, this continues to be great news. Prices are high, inventory remains low, and many buyers are stepping up to demonstrate how badly they want your home. As a buyer, this isn’t bad news; it’s just the reality of our Bay Area market. In fact, the current market may be more buyer-friendly than you realize or all of the sensationalized stories lead you to believe. Compared to earlier this year, many homes are sitting on the market longer and with less competitive bidding than we were accustomed to seeing in the springtime (read: lower down payments are competitive!). And keep in mind that even though 20%+ down payments are common, they certainly are not the rule. Many buyers are still landing the home they have always wanted with less than 20% down, and many lenders have special programs and promotions with great rates (will they be rising soon?) and no PMI requirements.

At the end of the day, a great agent can recommend and build a strong offer strategy regardless of the down payment amount. An even better agent will take the time to educate you on the merits and risks of your offer so you feel more confident and comfortable with the potential outcomes. When you are selling, a great realtor can make all the difference between identifying and attracting the most qualified and committed buyers versus generating unwanted traffic into your home and wasting time with weak offers. As such, if you know anyone presently or in the future that is contemplating a real estate transaction or simply wants to discuss the market or a property, I would be honored if you think of me. I would work tirelessly to ensure I exceed the already high expectations that would come from your trusted referral.