Having a down-payment is much more important today than it has been in the recent past. Not only will it determine what types of loans you will qualify for, but it might also be the only way you can qualify for some loans, period. You can have as little as 3% or as much as 20% depending upon other factors such as credit history and dept-to-income ratios.
Here are a few tips for accumulating a down payment:
- Save: As much as we all seem to hate to do this, it is the best way to accumulate money for a down-payment over time. You can look for ways to reduce your monthly expenditures to save toward a down-payment. This can be as easy as choosing not to go to Starbucks for coffee every morning and put that towards a down-payment, etc. You can enroll in an automatic savings plan at your bank to have a portion of your payroll automatically transferred into your savings accounts. Realistically, it takes most people a couple of years to save for their down payment.
- Borrow the down payment from your retirement plan: You will need to check the provisions of your retirement plan if you have this as an option. You can borrow funds from a 401(k) plan for a down payment or make a withdrawal from an Individual Retirement Account. Be sure you understand the tax consequences, repayment terms and/or possible early withdrawal penalties before you go this route.
- Move: If you have the time to do this, moving may be a viable option for you. You may be able to save additional funds by finding and moving into less expensive housing. You may also choose to move back in with parents or take in a roommate to reduce your current living expenses and contribute to your savings for a down-payment.
- Reduce other higher interest rate debt: Paying off credit cards will initially reduce your savings, but the money you will save from higher interest rates will pay-off in the long run.
- Make a deal with the seller: In some circumstances, it is appropriate to ask the seller to pay for your down-payment, if your loan program allows; or to carry a second-mortgage to cover your down payment. Typically, you will pay a slightly higher rate for a second mortgage of this kind.
- Sell some investments: If you have other property or possessions that you know longer want or determine you could sacrifice for a home, you can sell them.
- Get a second job and save your earnings: Take up a second or third job to make the extra money you will need for the down-payment of a house.
- Skip a year’s vacation: Sacrifice this year’s vacation and stay at home and save the money you would have used.
- Tax Return: You can always use your tax returns for a down-payment or your closing costs.
- Gift from Family: Parents and other family members will often be available to help children buy their first home and may have the means to give you a gift of money for a portion or all of your down payment.
Here are some alternative sources for getting a down-payment
No-down and low-down Mortgages
FHA Loans
The Federal Housing Authority (FHA), which is part of the U.S. Department of Housing and Urban Development (HUD), plays a significant role in helping low- to moderate-income families qualify for mortgages. FHA assists first-time buyers and others who would not qualify for a conventional loan, by providing mortgage insurance to private lenders. Interest rates for an FHA loan are usually the going market rate, while the down payment requirements for an FHA loan are lower than conventional loans. The required down payment can be as low as 3 percent and the closing costs can be included in the mortgage amount. You can also ask sellers to contribute to the down-payment, up to 3% of the purchase price, through third party non-profit companies, as long as FHA allows.
VA Loans
VA Loans are guaranteed by the U.S. Department of Veterans Affairs. Service persons and veterans, as well as their wives, can qualify for a VA Loan, which usually offers a competitive fixed interest rate, no down payment and limited closing costs. While the VA does not issue the loans, it does issue a certificate of eligibility required to apply for a VA loan.
Piggy-back Loans
A second mortgage that closes with the first. Often the first mortgage is for 80% of the purchase price and the “piggyback” is for 10%. The home buyer covers the remaining 10% with their down payment. (Some lenders will write a second mortgage of 15% or even 20% of the purchase price though that is becoming a rarity.)
“Carry Back” Mortgage
In the case of the seller “carrying back a second mortgage”, the seller loans you part of his or her equity. In this scenario, you would finance the majority of the loan with a traditional mortgage lender and finance the remaining amount with the seller. Typically you will pay a slightly higher interest rate on the loan financed by the seller.
Housing Finance Agencies
These agencies offer special loan programs to low- and moderate-income buyers, buyers interested in rehabilitating a home in a targeted area, and other groups as defined by the agency. Working through a housing finance agency, you can receive a below market interest rate, down payment assistance and other incentives.
The primary mission of Housing Finance Agencies is to boost home ownership in targeted areas, among first-time buyers and those with little money for down payments. Most of these non-profit agencies were funded with state government seed money and now operate independently.
Documenting Your Down Payment
You must be able to document where your down-payment is coming from for the lender. This not only gives the lender confidence in you as a borrower but also helps with security and fraud issues that lenders face today. Make sure you document the sources for the down-payment money as well as the closing cost monies. This money will be verified.
Acceptable Down Payment & Closing Costs Sources
- Cash in a bank account
- Mutual funds / stocks / IRA / 401K
- Proceeds from the sale of another property
- Gift from an immediate relative
- Third party non-profit assistance companies
Title Insurance is another major issue when purchasing a home.