Down Payment Types
Saving money for a down payment on your first home is easier said than done. It is best to combine saving for a down payment with other financial strategies. The best one will help you clear the down payment goal without jeopardizing your finances for the long haul.
Here are some options that first-time home buyers use to come up with a down payment. Not all of them will be right for you, so consider the benefits and drawbacks carefully. 62% of buyers are wrong about down payments.
1. Low down payment mortgages
Everyone thinks, lenders have to have 20% down, but many low-down-payment options are now available, especially for first-time buyers:
VA loans, which are backed by the Department of Veterans Affairs, and USDA loans, backed by the Department of Agriculture, offer 0% down payment options for borrowers who qualify. I’ve done many of these and the only trick is they have to appraise for the offer price. Some sellers are cautious as they should be. But I love helping Veterans and active military get into homes.
FHA loans, backed by the Federal Housing Administration, allow down payments as low as 3.5%. These are great. Your payment will be a little higher and you will probably have some Payment Mortgage Insurance, PMI. Conventional loans, which are not backed by the government, offer down payments as low as 3% to first-time home buyers with good credit. Usually in the 700s and up but that changes from lender to lender.
A smaller down payment requirement may enable you to buy a home and start building equity sooner. However, making a small down payment can trigger mortgage insurance, which protects lenders against loans that default, which is required on all FHA loans and on conventional loans with down payments of less than 20%. VA loans have a funding fee, which can be rolled into your monthly loan payment. A lower down payment usually means you’ll pay a higher interest rate. But the interest rates are very low now.
2. State and local down payment assistance
Many states have down payment assistance programs, implemented by government agencies, nonprofits, foundations, and even employers. The assistance usually comes in the form of grants or zero-interest, forgivable loans. The programs can have a geographic focus as wide as the nation or as narrow as a city. There are also hyper-local initiatives targeted as tightly as neighborhoods and even house by house.
I also know of several Title and Mortgage companies that will offer a discount to first-time home buyers and to seniors. Just ask me.
3. Down payment gifts and loans from friends and/or family
It’s not uncommon for buyers to get help from family members. Down payment gifts are acceptable to lenders. However, remember applying a gift toward a down payment involves more than depositing a check. The donors will have to verify that they made the gift, and they have the financial ability to make it. That may require them to provide bank statements as proof, along with a letter confirming that the donation is a gift and not a loan. Sometimes the funds need to be “seasoned” which means in most cases it has been in the account for at least 30 days. The donors often have to verify in writing not only that they offered the gift, but that they have the financial ability to make such a donation. They do not have to be a “qualified investor” (over a million in liquid capital. These are things that you should discuss openly with your lender of choice.
Drawbacks: Using a gift to supplement savings can help you clear the down payment threshold. Buyers who have to rely exclusively on gifts from family members may not be ready for the full cost of owning a home. Discuss this with your lender. Speaking from lots of experience, if you have a family member willing to offer help, take it.
4. Retirement account withdrawals or loans
Some first-time home buyers tap retirement savings or their 401K for a down payment, but this option should be approached with caution. The rules and consequences for using retirement money for a down payment before age 59½ vary by the type of account:
Employer-sponsored 401(k) plans may allow for early withdrawals or loans. You’ll pay income taxes and an additional 10% tax penalty on an early withdrawal. If your plan allows a loan, you must repay the money with interest to avoid income taxes and a penalty. Some 401(k) plans give you more than five years to repay a loan for a primary home. If you leave your job, loans must be repaid or rolled into an eligible retirement account by the next tax filing deadline, or you’ll pay taxes and a penalty on the borrowed money. Traditional IRA withdrawals for first-time home purchases are allowed, up to $10,000. You will pay income taxes on the withdrawn money but won’t face an additional penalty if the money is used to buy or build a first home. Roth IRA withdrawals are tax-free and without penalty for a first-time home purchase if you’ve had the account for at least five years.
Hint: Financial planners generally don’t recommend this strategy because most people are already behind on retirement savings. But you can’t live in your retirement account like you can in a home. Please consult your financial planner or tax consultant.