Whether you are a buyer or seller, this week’s article will help shed some light on both sides of the transaction. Today’s article came from an inquiry I received this week by a disheartened buyer who wrote:
“I have placed offers on two houses and lost on both. Please let me know if my offer of 3% down looks bad against offers that may have more down payment.”
There’s a lot of misconception out there that a low down payment offer is a weak offer. An offer is not a weak offer because of the down payment. There are only weak buyers. So long as there is a contingency for ANY financing, regardless of the amount of the down payment, if an issue arises with the buyer qualifying for the mortgage, your deal is dead.
If a low down payment offer meant that a seller would pass on that offer, virtually no veteran would ever own a home. VA loans offer 100% financing. Zero down is not low-down, it’s no-down! Here’s another astonishing fact about VA loans – throughout the last 2 decades, including the financial meltdown of 2008, VA loans on homes with little or no equity had the lowest overall foreclosure and default rate. This is an important fact because you cannot equate down payment with one’s ability to obtain financing or their ability to repay that debt.
In every transaction in which there is financing, the buyer/borrower must have acceptable credit, sufficient income, verifiable assets, and the collateral – the subject property, must be acceptable to lend upon. Each one of these components is separate, but a borrower must meet the requirements for all 4 in order to obtain financing. Failure in one aspect, and it’s not going to happen.
-You have terrible credit, great income, verifiable funds, and a great house you want to buy – not going to happen.
-You have excellent credit, but insufficient income, lots of money in the bank, and a perfect property – no loan either.
-You have excellent credit, tons of income, your down payment is from money you’ve stashed over years under your mattress (unverifiable), purchasing a newly built home – not happening.
-You have perfect credit, a great job with lots of income, not only do you have verified funds for your down payment, but you have a retirement account valued at more than the loan you re applying for, but the property you wish to purchase has foundation and termite issues – you won’t get conventional financing on this one either.
While there are specialty lending programs that can address the issues above, for the purposes of today’s article, we’re focused on conventional financing. I bring up the four pillars of financing because it is important for sellers and their agents to understand that when someone makes an offer with 3% down, they may in fact be more likely to successfully obtain their financing that another offer from someone putting 20% down. It’s not just the down payment amount that’s important.
So why is an all-cash offer the strongest offer one can make? If you eliminate the need for someone to obtain financing, all the checks and review into that’s person’s qualifications are omitted. If you’ve got the cash, then there’s no one’s stopping you from moving forward.
The most important factor for a seller from an all-cash offer is that it gets them off the hook for the sales price. An all-cash offer alleviates any 3rd party scrutiny of the subject property. There’s typically no appraisal.
And the appraisal brings us back full circle as to the only issue with a low-down-payment offer: What if the property doesn’t appraise at the negotiated sales price? Even if the buyer and seller negotiate a price somewhere in the middle, the person with the low down payment may not have additional resources to bring in any additional funds.
Here’s an example:
The purchase price is $420,000 with the buyer putting down 3% ($12,600). Their loan amount is 97% ($407,400). If the appraisal comes in at $400,000 and both sides agree to meet in the middle at $410,000, here’s how the numbers change. The loan amount is 97% of the $400,000 appraised value, which is $388,000. The buyer now needs to come in with $22,000, which is almost double their original down payment.
Let’s use the same example except the buyers are putting 30% down. The purchase price is still $420,000. The down payment is 30% which is $126,000 and the loan amount is $294,000. The same situation arises with the appraisal coming in at $400,000. Both sides agree to a final purchase price of $410,000. Because the buyers have a large down payment, that amount doesn’t change. The loan amount decreases because the purchase price was reduced $10,000. With $126,000 down on a purchase price of $410,000, the new loan amount would be $284,000. $284,000 against an appraised value of $400,000 is still a loan with a 71% loan-to-value.
You don’t have that flexibility when only putting 3% down so if there are issues with the property or issues with the appraised value, your offer might be considered a weak offer.
When I have buyers and buyer’s agents concerned about a perceived weak offer, I do 2 things. First, I educate the buyer’s agents as to the strengths of the buyer and any possible issues that could possibly arise. Second, I personally call the listing agent to provide them background on my clients as well. In so many situations today, buyers decide on a low down payment because they want to buy right away, but haven’t sold their existing home yet.
The key to any successful offer is communication between buyer and seller. If the seller is made aware of the situation as to why a buyer doesn’t have 20% down, but still has great credit and loads of income, it not only benefits the buyer, but it also benefits the seller. For it would be foolish for a seller to accept an offer from someone else with a higher down payment, only to have that transaction fall apart because that other buyer had issues with their income or some other aspect of their qualification.
Compliments of Alan Van Zee President | NMLS #: 297154 Hawaii Mortgage Company, Inc.