How to Understand Paying a Down Payment For Buying a Home

Buying a home like so many aspects of a consumer's life, almost always requires taking out a loan. When a consumer takes out a loan, they become the borrower and they receive the loan from a lender. The borrower pays the lender for the loan through interest. If the borrower makes good on the monthly payments or in repaying the loan, then the lender benefited by earning a profit through the interest paid with the principle as the borrower re-payed the loan over time. If a borrower does not make good on the loan, then the lender is in a sense punished for making the loan in the first place.

As a result it becomes a priority to the lender to figure out if a borrower will make good on the loan or not. If a lender establishes the borrower is highly likely to repay the loan, the lender will say the borrower is "low risk." The same is true with the opposite situation, if a lender is worried the borrower will fail or default on the contract, the borrower will be considered "high risk."

Risk plays an important part in how much the lender will effectively "charge" a borrower through the interest rate. The higher risk a borrower is, the more the lender will "charge the borrower." Charging a higher interest rate is a way for the lender to compensate for the higher risk of the loan. Same as saying, well, giving you money is more risky than giving this other person the money, but if you do make good on the loan, then I will earn more money in return.

One of the top mechanisms for the lender to decide how risky a borrower will be is the down payment. The down payment is how much a borrower puts down on the loan at the time the loan is taken out. The more the investor or borrower puts down as a down payment the less risky they are because they are effectively "investing" more into the home.

An example of this is a short story of two buyers. John and Jack. Both are looking to own a home in the same neighborhood around the same price. Both work the same job with the same hours and the same pay. The only difference is that John has been saving every spare cent for the last year and a half while jack spent every spare cent partying and clubbing. The value of the home they are buying is $100,000.00. The bank asks for their down payment and John offers $25,000 down on his house and Jack can only offer $3,000 down on his home.

The bank, who is the lender, now knows one of two things about each borrower. One, that John was able to save money probably by discipline and sacrifice while Jack couldn't making John a much less risky borrower, which is currently true. The second thing they know for sure, is that John will be around eight times more invested in his home than Jack will be. The bank can deduce that if times get rough, it will be a way easier thing for Jack to walk away from his home and default on the loan than it will be for John. To compensate for this risk, the bank will charge a steeper interest rate on Jack's loan than they will on John's loan. It is wise to save money and pay more money down on the original down payment.

This article is brought to you by Juhlin Youlien who writes for Our Best Real Estate, a website featuring Fountain Hills AZ homes for sale and surrounding areas. Other features include Tempe AZ homes for sale and all major Phoenix Metropolitan Cities. Services include comprehensive information and real estate brokering through out Arizona.

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Jeremy Moore

Jeremy Moore

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