Buying With 5% Down When the DTI Is Tight
Aisha and Tom have combined gross income of $92,000, or about $7,667 per month. They have $48,000 in savings, no separate emergency fund, and monthly debt payments of $610: $340 for a car loan and $270 for student loans. They are under contract on a $310,000 house and plan to make a 5% down payment of $15,500. Their lender estimates closing costs at 3% of the price, or $9,300, and they expect $6,000 for moving and immediate repairs. The 30-year fixed loan would be $294,500 at 6.75% APR. Annual property tax is $3,600 and homeowners insurance is $1,800. Private mortgage insurance would cost 0.55% of the loan balance per year, and HOA dues are $45 per month. The lender's automated approval is conditional because the back-end ratio is tight. They ask whether they should proceed, wait and save for 20% down, or change the loan structure.
1. Calculate the front-end and back-end ratios and the post-closing reserves. What do the numbers say about proceeding?
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Principal and interest on $294,500 at 6.75% for 30 years is about $1,910 per month. Add property tax of $300, insurance of $150, PMI of about $135, and HOA of $45, for total housing cost of about $2,540.
Front-end ratio: $2,540 ÷ $7,667 = 33.1%. Back-end ratio: ($2,540 + $610) ÷ $7,667 = 41.1%. Conventional guidelines often use 28/36, while FHA often allows 31/43; a 41.1% back-end ratio is therefore tight for a conventional loan and may require compensating factors or a higher rate.
Reserves: $48,000 − $15,500 down − $9,300 closing − $6,000 moving/repairs = $17,200. That is about 6.8 months of the $2,540 housing payment, but it is also their entire emergency fund. A single roof repair or job disruption could wipe it out.
Judgement. The payment is not automatically unaffordable, but the combination of a 41% back-end ratio, PMI, and thin reserves makes this a high-risk purchase. They should either reduce the purchase price, pay down the student loan or car loan first, or wait until they have a larger down payment and a separate emergency reserve.
2. What are the trade-offs of waiting to put 20% down versus buying now with PMI? Include the PMI cost and how PMI removal works.
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Buying now costs 0.55% × $294,500 = $1,620 per year, or about $135 per month, in PMI. With 20% down, the loan would be $248,000 and there would be no PMI. At 6.75%, principal and interest on $248,000 is about $1,608, plus $300 tax, $150 insurance, and $45 HOA, for a total of about $2,103. That is roughly $437 per month less than the 5%-down scenario, before considering the smaller loan balance.
But waiting requires a $62,000 down payment plus closing costs and moving costs - roughly $77,000 - versus $48,000 available now. They would need to save about $29,000 more, plus maintain an emergency fund. Waiting also exposes them to rent increases and interest-rate changes.
PMI removal rules. On a conventional loan, the borrower can generally request removal when the principal balance reaches 80% of the home's original value, with a good payment history and possibly an appraisal. PMI must generally terminate automatically at 78% of original value based on the amortization schedule. Paying down the loan faster can reach 80% sooner, but they should confirm the servicer's rules.
Judgement. Waiting for 20% is financially stronger if they can save aggressively and the housing market does not run away from them. Buying now is defensible only if they keep a real reserve and plan to stay long enough to recover closing costs.
3. The appraisal comes in at $300,000, not $310,000, and the seller will not lower the price. How does that change their financing, and what should they do?
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Lenders generally base the loan on the lower of the purchase price or appraised value. With a $300,000 appraisal, a 95% loan is $285,000. Because they agreed to pay $310,000, the down payment becomes $310,000 − $285,000 = $25,000, not $15,500. That is an extra $9,500 in cash.
Cash after closing would be $48,000 − $25,000 − $9,300 − $6,000 = $7,700, or about three months of housing payments. That is a dangerous reserve. PMI would still apply, and the lender may reprice the loan because the LTV and risk profile changed.
Options. They can renegotiate the price to $300,000, ask the seller to credit closing costs, bring the extra cash and accept thin reserves, or terminate under the appraisal contingency if they have one. Walking away may cost the inspection and appraisal fees, but proceeding with almost no reserve is the larger risk.
Judgement. They should try to renegotiate to the appraised value or ask for a seller credit. If the seller refuses and they cannot restore at least a three-to-six-month reserve after closing, they should not proceed. The appraisal gap is a financing problem, not just a price disagreement.