I am often asked by buyers, “Why does the seller care about my down payment amount? As long as I am satisfying the building’s down payment requirement, and the bank has approved the loan, aren’t they getting their money at the closing table whether I ‘put down’ 20%, 50% or 100%?”

It is a very reasonable question. Unfortunately, the answer is more complicated than you might think. 100% of the purchase price will certainly be delivered at the closing whether the bank is providing 8% or 80% of the funds. However, the seller being “made whole” is only one small piece of the puzzle and doesn’t take into account two major factors in any purchase – risk and competition.

In every deal, both the buyer and seller assume some amount of risk. Of course, each would rather the other take the majority of the risk, and both sides will do their best to transfer the risk during the negotiation process. In a Buyers’ Market, the risk tends to be shouldered by the seller who must do anything and everything to attract a buyer (low down payments, marginal buyers, significant markdowns on price, etc.). However, in a Sellers’ Market, the buyer often shoulders the majority of the risk (due to competition from other potential buyers and lack of other suitable options) in order to create a value proposition for the seller. And, although certain segments of the market seem to be getting a more “buyer friendly”, we are still in a market in which inventory is below the historical average, and sellers in most cases still have the upper hand.

How does down payment increase or mitigate the sellers’ risk?

The sellers’ goal is to sell their home. Their actions at various points throughout the deal may contradict that premise, but it is reasonable to assume that’s their ultimate goal. In the meantime, they are responsible for the costs of “carrying” the home until it is sold and – once a contract is fully executed – they are “stuck” with their choice of buyer until the buyer is approved by the building and bank or, heaven forbid, they are denied by the building or bank. Since in many cases the process lasts 2-4 months, it is important that they – rather, their real estate professional – get it right the first time.

Let’s first address the typical “minimum” down payment in NYC. As a practical matter, co-ops in NYC – which represent the majority of available apartments at any given time – require at least 20% down (unless it is a sponsor unit in which case the required minimum down payment may be lower – but that is another article). That 20% figure has nothing to do with the owners’ preference or the banks’ policies, it is a building rule. But let’s assume you are purchasing a condo in which case you can technically finance up to 90% of the purchase price (or more in some cases). Even though you can technically get away with a lower down payment, practically you are faced with two potential problems. First, many lending institutions will only lend up to 80% Loan-to-Value (LTV). “80% LTV” means the bank is willing to lend a borrower up to 80% of the appraised value of the home (notice I underlined term “appraised value”; we will get back to that in a bit). Second – and more important from a practical standpoint – many sellers are very skeptical of moving forward with a purchaser financing more than 80% (or even at or near 80%) due to the addition risk they take on in that scenario.

Sidebar: What is a “Mortgage Contingency” and why do I care?

The Mortgage Contingency is a common clause in a contract of sale which states that if the buyer is unable to obtain a mortgage commitment within an agreed upon timeframe they are legally allowed to walk away from the purchase and receive their contract deposit back without penalty. If the buyer loses their job before they receive a mortgage commitment and the bank is no longer willing to give them a loan, the mortgage contingency applies. If the bank denies the building for some reason before they issue a commitment (lawsuit, bad financials, etc.), the mortgage contingency applies. If the bank is unwilling to loan the purchaser the amount of money they need (difference between their down payment and the purchase price), the mortgage contingency applies. In other words, the mortgage contingency is a kind of safety net for those buyers who are financing.

As you can imagine, a seller would prefer that the buyer “waive” their mortgage contingency and assume the risk associated with obtaining a loan commitment – whether it is a problem with the buyer, the building or the bank. That said, sellers generally know whether their building is likely to be approved by some, most or all banks (and take steps to mitigate that risk early on if necessary), and it is common to “vet” a buyer to determine if their employment is (relatively) stable in order to mitigate the risk of the buyer being denied a loan. However, an issue stemming from an appraisal is not as easy to predict. Any gap between contract price and appraised value will jeopardize the deal if the buyer is financing 80% (or more) of the purchase price and there is a mortgage contingency in the contract of sale.

Here’s an example of how the Mortgage Contingency can potentially scuttle a deal.

Let’s assume the buyer is putting down 20% (financing 80%) on purchase price of $1,000,000 – a down payment of $200,000. In order for the bank to agree to lend the remaining $800,000 (assuming 80% LTV), the apartment must appraise at or more than the purchase price of $1,000,000. Although, most apartments now tend to appraise right at the purchase price, it is possible for an appraisal to come in a little “light”. The appraiser uses prior building and neighborhood comparables (“comps”) to determine valuation for the bank. In a rising market, you can imagine that the recent “comps” may “lag” behind the current pricing – causing the apartment to “under-appraise”. Using our example, let’s assume the apartment appraises for $950,000 rather than the purchase price of $1,000,000. Since the bank uses the appraised value to determine the loan amount, and will only lend 80% LTV, the bank will lend $760,000 to the buyer ($950,000 x .80 = $760,000) based on the appraisal. As we stated earlier, the buyer planned to put down $200,000 and finance $800,000. We have a $40,000 gap! But remember, our buyer has a Mortgage Contingency – they therefore have a few choices;

1. Add an extra $40K to their down payment and move forward with the purchase
2. Exercise their Mortgage Contingency and “walk away” from the purchase
3. Attempt to renegotiate the price with the seller based on the appraised value – a less likely scenario in a sellers’ market and an option the seller has the right to refuse.

Obviously, the seller would prefer the buyer choose the first option and move forward with the deal, but they cannot predict or force that outcome. However, sellers can significantly reduce or eliminate the risk of this potentially deal-ending setback by choosing a buyer who “putting down” considerably more than 20% (30+% to “all cash”) as the additional down payment acts as a “buffer” between a possible under-appraisal and the 80% LTV requirement. And that’s why a seller cares so much about your down payment amount!

This discussion leads to another common question I get from buyers, “So, is it even possible to purchase an apartment with 20% down in this market?” Absolutely! It may make the road a little more difficult – and certainly makes Preparation and Game Plan even more essential – but it is possible. How can you help yourself if you are a 20% down buyer? First, having a little extra cash to dedicate to the down payment if the apartment doesn’t appraise may give comfort to a seller and/or give you additional comfort to “waive” your Mortgage Contingency up to a percentage of the purchase price. Second, you can appeal to the seller in another way – namely PRICE. Always try to put yourself in the shoes of the seller. Would it be worth it to the seller to take a risk on a 20% down buyer to make an extra $20,000? How about $50,000? As long as the seller is willing to assume some risk – and you are willing to make it worth their while to do so – you will put yourself in the position to win.

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My name is Eirik Davey-Gislason and I work in real estate in New York City. Unreal Estate is an opportunity for me to educate my audience and have a little fun in the process.  By sharing, preparing and advising readers on what to expect, what is normal, what is right, and what is wrong, I hope to do my part to give valuable guidance, expose the wrong-doers when necessary and shape the future of this dysfunctional thing we call NYC Real Estate.