You do not say what type of first lien loan for which you are applying. I would presume it is either FHA or conventional (Fannie Mae/Freddie Mac guidelines). You also say that the Down Payment Assistance Program (DPA) that you have been approved for is a grant. It may be a grant, i.e. the city gives you the DPA, or it may be a second lien on the property, referred to as a Community Second by Fannie Mae.
Usually the DPAs cities provide are silent seconds. With a silent second there are no payments required, but if you sell the property or no longer owner occupy it then you must pay off any unforgiven portion of the balance of the DPA.
Both FHA and conventional guidelines allow for DPA funds from a government source to be used as down payment and closing costs. There is no requirement for the borrower to provide any of their own funds. So if the city requires 3.5%, then that should be the only requirement. There have been no recent change of secondary market guidelines, either FHA or conventional, from 3.5% to 5% required borrower contributions from their own funds in this situation.
It may be that the loan officer you are working with does not have a very clear idea of the underwriting guidelines for either FHA or conventional when combined with a governmental DPA program.
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THANKS, We are trying to go conventional and the DPA is a silent second w/ no payments for 30 years or untill you sell the house.
That is the strange thing because the lender has been very knowlegdable through the whole process and even she is confused what is taking so long right now.
I guess now they are saying that the loan to value ratio is too high