Coming up with a down payment is probably the biggest obstacle for first-time home buyers. The suggested down payment is typically 20 percent. On a $250,000 home, that’s $50,000.
In a perfect world, you would set aside a decent amount of money every month for a few years until you reach your down payment goal. But the reality is that if you’re in a rising housing market with low interest rates, waiting to save up could actually cost you money in the long run. The great news is, you do not have to win the lottery or wait and watch housing prices expand more quickly than your savings. Understand that you have down payment options.
How Much Do You Really Need?
Traditionally, 20 percent is the standard for down payments, for a lot of exceptional reasons. You’ll find more lenders to select from, lower interest rates and you won’t pay any form of the dreaded private mortgage insurance (PMI). You have to understand that there are lower down payment loans that may make sense. If you are a U.S. veteran, you can even get a zero-down VA loan without any PMI.
If you qualify for an FHA loan, you can get in with just 3.5 percent down. An FHA loan doesn’t require the same exceptional credit score that the Conventional 97 does and may even come with a lower interest rate. But you’ll be paying the PMI for the life of the loan if you put down less than 10 percent, so our real estate agent suggest you carefully crunch the numbers prior to choosing.
Most conventional mortgages begin with a minimum down payment of 5 percent, with PMI required. For a $250,000 house that’s $12,500 upfront cash, not including any closing costs.
Where’s the money going to come from?
Gifts from parents or family members are the down payment plan for a lot of us. But in this case, getting them to write the check isn’t your only hurdle. You’re going to have to account for the gift to your lender. Don’t hope they won’t notice the $10,000 deposit into your savings account last month. They will.
And they will want to see a letter from your parents or whatever family member gave it to you, confirming that it’s a gift and not a loan that you’ll need to repay along with your mortgage. (And it does need to be a family member. Lenders look askance at anything unusual in this arena. Be ready to explain any large gifts that fall outside of what they might expect.)
There are also limits on gift funds. Right now the annual gifting limit is $14,000 to an individual, per person, prior to taxes. If your parents each make a gift to you, that’s $28,000. If you are married or purchasing the house with someone else, your kind parents can gift that much to each of you, bringing the total to $56,000 a year. But don’t go over that amount for the entire year.
Down payment assistance programs are another alternative option for down payment help. Unfortunately, many home shoppers doing even know that these programs are out there. The great news is that sites such as the Down Payment Resource Center let you search for programs near you.
If it seems counterintuitive to go into debt to make a down payment on more debt, you are correct. But purchasing a home is different than other types of debt, mainly because it’s an investment that will hopefully appreciate. Nonetheless, think about this option carefully prior to committing to it. And wherever you borrow the funds from, you need a solid plan for repaying it. Similar to any investment, there is no guarantee your home value will go up.
Mortgage lenders will almost never lend you money if your down payment comes in the form of a loan from your parents. They, understandably, want you to have skin in the game. That’s not to say people don’t violate this rule.
But you still have a non-legally binding understanding. How will you repay them? Will it be in small monthly payments or are you going to give them their money back in five years when you sell the house or refinance it? Or are you planning on producing a grandchild who will so enthrall your parents they will forget about the money? (Caution: This is an expensive repayment plan.) What happens if Mom loses her job or needs to retire early and they need the money back sooner than expected? You can’t amortize guilt, but you might want to in this situation. Think long and hard before taking this route.
Another great option, and one you should be fully aware of, is to borrow from yourself by taking out a loan from your retirement funds. If you borrow from your 401(k) to make a down payment, you’ll be repaying yourself over time.
But be a bit cautious. If you lose your job or even just make a switch to a new employer, you’ll have to repay the loan at once or be subject to hefty early-withdrawal fees. You’ll also be repaying the loan with after-tax dollars. If you have happen to have an IRA, you can take up to $10,000 out without penalty to buy a primary residence if you are a first-time home buyer. A majority of experts will advise you, however, that the risk is simply not worth the potential cost.
Saving for a down payment is still a time-honored, financially solid plan. If you have credit card debt, our agents suggest you focus on paying that off first. There is a high chance that whatever you are paying in interest on those is going to be higher than any home appreciation. In addition, eliminating that debt will highly improve your debt-to-income ratio and help you get a better mortgage.
If you’ve got non-retirement investments, maybe a forgotten savings bond or some stock you bought and held on to, think about whether you want to cash them out and reinvest the funds in a house. Downsize your rental and stash the savings each month.
If you are really low on funds, and you can’t put anything of substance toward a down payment savings account each month, you may not be ready for homeownership. Once you own your home, if a pipe bursts or your furnace goes out, you no longer get to just call the landlord.
While you do have that option, stash away cash each month. Our real estate agents suggest that if you get a bonus or other windfall, save it. Saving for a down payment is amazing practice for saving money to take care of unexpected home repairs.
When thinking about your down payment and loan options, it’s also a good idea to talk to a local lender early in your home search. They can asses your financial situation and help you understand what type of loans you’d be eligible for.