Saving for a down payment when you have a boatload of bills is no easy task, but first-time homebuyers with good credit have an edge: They often can put just 3% down, and they have access to a host of down payment assistance programs.
A down payment gift from a family member, and sometimes a close friend, is allowed for most loan types. Then there are gifts of equity from home sellers.
Smart Ways to Save Up for a Down Payment
Here’s the lowdown on down payments, from 3% to 20%, to buy a home before you go shopping for a mortgage.
1. Low Down Payment Mortgages
Conventional loans, the most common type of mortgage, are offered by private mortgage lenders, such as banks, credit unions and mortgage companies. Many of those lenders allow a down payment of 3% for a fixed-rate conventional conforming loan.
To qualify, borrowers usually will need to have a credit score of at least 640 and a debt-to-income ratio of 43% or less. Income limits may apply.
Putting 20% down will allow a borrower to avoid private mortgage insurance (PMI) on a conventional loan.
Government-backed loans like FHA and USDA mortgages are designed to help low- to moderate-income borrowers or those with lower credit scores.
An FHA loan requires as little as 3.5% down on one- to four-unit owner-occupied properties as long as the borrower occupies the building for at least one year. To qualify for 3.5% down, your credit score must be 580 or higher. Someone with a credit score between 500 and 579 may qualify to put 10% down.
A VA loan, for veterans, active-duty military personnel, National Guard and Selected Reserve members, and some surviving spouses, requires no down payment. Borrowers can buy a property with up to four units, as long as the borrower occupies the property throughout the ownership. There is no stated minimum credit score, but generally speaking, lenders require a minimum credit score of 580 to 620 to qualify.
A USDA loan, for properties in eligible rural and suburban areas, also requires no down payment. Lenders typically want to see a credit score of at least 640, and household income can’t exceed 115% of the area’s median household income.
USDA and VA loans typically come with lower interest rates than conventional or FHA loans, but a USDA loan requires a guarantee fee, a VA loan requires a funding fee, and an FHA loan, upfront and annual mortgage insurance premiums (MIP).
It pays to understand PMI vs. MIP in understanding the total costs of your loan.
And lender-paid mortgage insurance has its pros and cons.
2. State and Local Down Payment Assistance
State, county, and city governments and nonprofit organizations offer down payment assistance programs to help get first-time homebuyers into homes. (By the way, the definition of who qualifies as a first-time homebuyer is more expansive than it seems.)
Down payment assistance may come in the form of grants or second mortgage loans with various repayment or loan forgiveness provisions.
HUD steers buyers to state and local programs.
The National Council of State Housing Agencies has a state-by-state list of housing finance agencies; each offers a wealth of information designed to boost housing affordability and accessibility.
3. Down Payment Gifts
“Hey, Mom and Dad (or Uncle Clyde or Aunt Betty, or My Dear Girlfriend), I’d love it if you gave me a large cash infusion to help me buy a house.” It just rolls off the tongue, right? In fact, one or more loved ones may be willing to pitch in toward your down payment or closing costs.
Under conventional loan guidelines, gift money for a principal or second home is allowed from someone related by blood, marriage, adoption, or legal guardianship, or from a domestic partner or fiance. There’s no limit to the gift, but conventional loans may require borrowers to come up with a portion of the down payment.
FHA guidelines allow gift money from relatives, an employer, a close friend, a charitable organization, or a government agency that provides homeownership assistance.
With USDA or VA loans, the only people who cannot provide gift funds are those who would benefit from the sale, such as the seller, lender, real estate agent, or developer.
A mortgage gift letter signed by donor and recipient will be required, verifying that the down payment funds are not expected to be repaid. A lender may also want to track the gift money.
Then there are gifts of equity, when a seller gives part of the home’s equity to the buyer to fund all or part of the down payment on principal or second homes. For FHA loans, only equity gifts from family members are acceptable.
A signed gift letter will be required.
4. Crowdfunding a Down Payment
Crowdfunding to help buy a house? It’s possible with sites like GoFundMe, Feather the Nest, HomeFundIt, and even Honeyfund, set up as a crowdfunder for honeymoons.
Feather the Nest isn’t associated with a mortgage lender, so donation seekers can decide where to go for a loan. It charges a fee of 5% for every contribution.
HomeFundIt charges no fees, but you must pre-qualify and then use CMG Financial for your home purchase. The site shows a money match toward closing costs for first-time buyers.
GoFundMe charges 2.9% plus 30 cents per gift.
For Honeyfund, U.S. residents receiving U.S. dollars via PayPal are charged 3.5% plus 59 cents per transaction.
First-time homebuyers can
prequalify for a SoFi mortgage loan,
with as little as 3% down.
5. Retirement Account Withdrawals or Loans
It might be a good idea to explore all options for getting cash before tapping your 401(k) savings account.
As you probably know, taking money out of your 401k before age 59 ½, or before you turn 55 and have left or lost your job, is met with a 10% early withdrawal penalty and income tax on the amount. So withdrawing money early from this tax-deferred account has a painful cost and impairs long-term growth.
A traditional IRA, on the other hand, allows first-time homebuyers to take an early withdrawal up to $10,000 (the lifetime limit) to use as a down payment (or to help build a home) without having to pay the 10% early withdrawal penalty. They still will have to pay regular income tax on the withdrawal.
Your employer’s plan might let you borrow money from your 401k and pay it back to your account over time, with interest, within five years, in most cases. You don’t have to pay taxes and penalties when you take a 401k loan, but if you leave your current job, you might have to repay the loan in full fairly quickly. If you can’t repay the loan for any reason, you’ll owe taxes and a 10% penalty if you’re under 59 ½.
Then there’s the Roth IRA. You can withdraw contributions you made to your Roth any time, tax- and penalty-free.
If you take a distribution of Roth IRA earnings before age 59 ½ and before the account is less than 5 years old, the withdrawal may be subject to taxes and penalties. You may be able to avoid penalties but not taxes if you use the withdrawal (up to a $10,000 lifetime maximum) to pay for a first-time home purchase.
If you’re under age 59 ½ and your Roth IRA has been open for five years or more, a withdrawal of earnings will not be subject to taxes if you use the withdrawal to pay for a first-time home purchase.
Recommended: First-Time Homebuyers Guide
How to afford a down payment on a house? First-time homebuyers may benefit from assistance programs, down payment gifts, and mortgage types that require little down.
Consider SoFi mortgage loans. Qualified first-time homebuyers can put just 3% down, and checking your rate takes only minutes.
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