SANTA CRUZ (October 31, 2009) - When our government was trying to figure out how to pull this country out of the Great Depression in the early 1930s one of the solutions was to increase homeownership. Up until then banks required large down payments (up to 50 percent!) and they would only extend loans for 3 – 5 years. Needless to say, we were a nation of renters.

In order to increase homeownership the Federal Housing Administration (FHA) loan program was created. FHA is not just for first time home buyers and it offered the opportunity for the masses to become home owners by providing long term fixed rate financing with a minimum down payment. The same is true today. Out of the mortgage debacle of 2007 came FHA to the rescue. When President Bush increased the FHA maximum loan amount from $362,000 to $729,750 in early 2008, it opened up the possibility of homeownership to thousands who could not have afforded it under the guidelines of the mortgage industry as it was at the end of 2007.

Coming up with the down payment for an FHA loan is surely the least challenging of all possible loan options. FHA loans allow a homebuyer to buy a home with just 3.5 percent down AND the down payment can all be a gift from a relative. To top it off, the seller can pay for ALL of the buyer’s closing costs.

Compare that with conventional financing that generally requires a minimum down payment of at least 10 percent if the loan amount is under $417,000 and 15 percent if the loan amount is above $417,000. The gift rules are much stricter with conventional financing as well. If a gift is received for some of the down payment, conventional financing mandates that the homebuyer must have at least 5 percent of the sales price of his own money into the transaction.

Mortgage insurance is required in all cases when the down payment is less than 20 percent. FHA loans require mortgage insurance on all loans, regardless of the size of the down payment. While mortgage insurance adds about one half to three quarters of one percent to the interest rate, it provides the opportunity to buy a home with a small down payment to countless families who would otherwise be unable to buy a home.

The $8,000 federal tax credit for first time homebuyers can be used to offset the cash required to buy a home but will not be available to the homebuyer until after escrow closes. Ask your tax accountant for details.

In addition to the cash required for the down payment, cash is required to cover the buyer’s closing costs. These costs, when factoring in interest, property taxes and homeowner’s insurance can run as high $10,000 - $19,000, depending on the sales price and loan amount. Most lenders (FHA as well as conventional) allow the seller to pay these costs for the homebuyer. Prospective homebuyers who are short on cash (and who is not?) should be asking the seller to pay for their closing costs at the time the offer is made or in the counter offer stage of negotiations.

This column is written every Saturday by Peter Boutell, Certified Mortgage Planner and a principal at Santa Cruz Home Finance. You may reach him at (831) 425-1250 of email him at Peter@SantaCruzHomeFinance.com.