Answer: Not necessarily. This question causes lots of confusion because the rules have changed over the years. Many of us go
to our folks or trusted older family member for advice when we first start looking into buying a home. Unfortunately, often
the advice is correct but out of date. Today there are several alternatives.
First of all, it helps to understand the historical reasons for 20% down. Banks
track how much it costs to foreclose on real estate. Each year this
averages 18-22% of the value of the home. These costs include legal fees, repairs (evicted owners rarely leave with everything
in good shape), listing commissions, selling commissions, title fees, escrow fees, taxes (local, county & state), and
the like. Therefore, whenever mortgages exceed 80% of the value if the home, the investor is at risk. Today there are several
ways to address that risk:
1) PMI - Private Mortgage Insurance. Mortgage insurance is a contract that insures the lender against loss caused by a mortgagor's default on
a mortgage. Mortgage insurance issued by a private company is called "PMI". Mortgage insurance can also be issued by a government
agency like the FHA and is called MI.
2) LPMI - Lender-Paid Mortgage Insurance. With these programs investors charge a
higher rate to "self insure" against the risk. The advantage for borrowers
is that the interest is tax deductible, where PMI or MI isn't.
3) Combo Loans - For these programs borrowers have a 1st mortgage that is 80%
or less of the value and a 2nd mortgage to close
the gap between their down payment and the balance remaining. For example 5% down combo loans are referred to as 80/15/5
and 10% down combo loans are 80/10/10. The advantage for borrowers is that they can write off the interest on both loans.
They can also work to pay the 2nd off faster, leaving them in a comfortable equity position.
4) Alternative Lending - These are typically loans with a shorter commitment to a fixed rate, often 2-5 years. After that time they become Adjustable
Rate Mortgages, often with higher margins that force borrowers to refinance out of them quickly. Investors manage to the risk
and require pre-payment penalties to prevent borrowers from refinancing too quickly.
