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The Down Payment

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For most first-time home buyers, saving enough money for a down payment is a major hurdle to owning a little piece of paradise. Traditionally, lenders have preferred a down payment of at least 20% of the home's purchase price. However, lenders will almost always accept less than that if the borrower takes out private mortgage insurance. In the last few years, innovative programs have made it possible to put down anywhere from 0% to 3% of the value of a home and still qualify for a mortgage.

How Much Should You Put Down?

If you've got the money, there are advantages to putting 20% down. For one thing, you immediately have substantial equity in your home. This may be important to you psychologically, and that counts. In addition, you'll avoid having to pay private mortgage insurance.

If you haven't got the money, then you'll want to learn a little more about the private mortgage insurance mentioned above.

Private Mortgage Insurance (PMI)

Private mortgage insurance protects a lender in the event that you default on the loan. Lenders generally require mortgage insurance on loans with low down payments because experience shows that a borrower with less than 20% invested in a house is more likely to default on a mortgage. You're a Fool and you're not going to do this, we know. But they don't know it yet.

Mortgage insurance also enables lenders to grant loans that would otherwise be considered too risky to be purchased by third-party investors like the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). The ability to have a market for the mortgages means that lenders can loan more money to people like you.

The good news about insurance is that you don't have to pay it forever. You can usually cancel it after you have at least 20% equity in the home. (Contact your loan servicer to find out the procedure for doing this.) Typically, you'll be required to get an appraisal on the property. This will cost money (a few hundred dollars), but could be worth it in the long run. Some lenders may have fancy ways to allow you to avoid PMI while still putting down less than 20%. For example, they might offer you a second-tier mortgage to make up the difference. The interest on the second loan will be higher, but it will be tax deductible, whereas PMI is not. As always, it pays to do your homework and explore as many options as you can with your lender.