Practice what you learned

Select the advice you feel is best.

Imagine a friend of yours, Erika, comes to you looking for advice. She has saved $20K, and would really like to buy a home, but is not sure whether she should use her money to pay off her debt, or whether she should use it as a down payment. Her debt-to-income ratio is 15%. What advice would you give her?





Correct! Many people think that lenders want them to be debt free. Not so.  They just want a borrower’s debt-to-income ratio to be within guidelines. As long as a borrower’s ratios are less than the mid-40% range, savings would be better spent on a down payment than entirely clearing up debt (assuming that home buying, not paying off debt, is the borrower’s priority).

As for paying off debt load and then aiming for 100% financing – bad idea. Lenders often require down payments. And the bigger the down payment you can provide, the better. Here’s why:

  • The larger a down payment, the less you have to borrow, and therefore, the lower your monthly payments.
  • If you have a very small down payment, i.e., 5% or less, you will be eligible for fewer types of mortgages and may be charged a higher interest rate.
  • The bigger the down payment you are able to put down, the more banks will be willing to loan you. (And the more willing they will be to loan to you at all.)
  • For any down payment less than 20% of the asking price, you will be asked to pay Private Mortgage Insurance (PMI).
  • Lenders sometimes allow sellers to cover less of the closing costs when a buyer has a very small down payment.
Incorrect. Many people think that lenders want them to be debt free. Not so.  They just want a borrower’s debt-to-income ratio to be within guidelines. As long as a borrower’s ratios are less than the mid-40% range, savings would be better spent on a down payment than entirely clearing up debt (assuming that home buying, not paying off debt, is the borrower’s priority).

As for paying off debt load and then aiming for 100% financing – bad idea. Lenders often require down payments. And the bigger the down payment you can provide, the better. Here’s why:

  • The larger a down payment, the less you have to borrow, and therefore, the lower your monthly payments.
  • If you have a very small down payment, i.e., 5% or less, you will be eligible for fewer types of mortgages and may be charged a higher interest rate.
  • The bigger the down payment you are able to put down, the more banks will be willing to loan you. (And the more willing they will be to loan to you at all.)
  • For any down payment less than 20% of the asking price, you will be asked to pay Private Mortgage Insurance (PMI).
  • Lenders sometimes allow sellers to cover less of the closing costs when a buyer has a very small down payment.

What, Why, How Check your understanding

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