Ways to Finance Your Down Payment

Ways to Finance Your Down Payment


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In many ways, the biggest barrier to home ownership is the down payment required for most mortgages. Even if one has a good credit score and a steady source of income, often a few years of financial discipline are necessary in order to come up with five figures’ worth of cash ready to put down on a home. Things can get in the way, emergencies happen, and unexpected expenses come up.

 

Many times, first-time buyers assume that they need to come up with 20% of the cost of the average home in order to even buy their home in the first place, and that’s before they start thinking about getting the best deal on their mortgage. While this is more or less true, a 20% or even 10% down payment isn’t always required. In reality, the average down payment is only 6%. Buyers should be aware of the multitude of options, and their ramifications, when it comes to making their down payment.

 

Your choice of loan depends on whether you want to make a down payment, and there absolutely are benefits of making one. For one, you’ll carry a lower loan balance, which can lower your monthly payments, decrease the amount of interest you pay on the loan, or shorten the term of the loan. You’re also likely – but not guaranteed – to get a better deal on the mortgage (this is because lenders look at a lot of different things besides your down payment).

 

You might also be able to avoid mortgage insurance, which is standard practice on low-down-payment loans because the higher the down payment, the lender generally assumes less risk. You have more loan options from which to choose from, and it’s really though this variety, rather than the size of your down payment itself, that you may be able to find the best deal.

 

But there are also drawbacks to making a down payment, especially a large one. It’s a greater risk to you because it’s such a large cash sum, and you’re not guaranteed to receive a better mortgage rate despite a large down payment. You may very well deplete your savings to make a down payment, which can decrease your cash buffer for emergencies.

 

Last week, we talked about FHA and VA loans. One of the defining characteristics of FHA loans is their flexible credit requirements and 3.5% down payment minimum. Buyers don’t even have to come up with the full 3.5%, either: usually only 1.75% upfront is required and the remaining 0.85% of the loan balance is paid per year in 12 equal installments along with the mortgage payment. On a $200,000 loan, that’s $3,500 upfront and $141 per month. The upfront fee can also be rolled into the loan amount and doesn’t need to be paid in cash.

 

Obviously, there are some risks for the buyer here. Lenders are usually willing to take on borrowers for FHA loans because the government guarantees them. This removes some natural barriers that might otherwise dissuade someone from purchasing a home (and could spell trouble for unwary or inexperienced buyers down the road), but if your income is steady and your financial position is good, then an FHA loan may be the best way to buy a home with a lower down payment obligation. Understand, though, that mortgage insurance will be required, which may raise your monthly payments further in addition to any down payment rollovers.

 

The VA home loan is a zero down mortgage option for homebuyers with current or former military service. It’s often a great choice for veterans because it offers 100% financing and doesn’t require great credit. VA loans require no down payment, but borrowers put any amount down if they want to reduce the overall cost of the loan. As the name implies, eligibility is based on current or former military service so this option isn’t available to just anyone.

 

USDA loans are lesser known but offer 100% financing and a 0 down mortgage option to those buying in non-urban areas. These are known as Rural Development (RD) or Rural Housing loans. If you’re purchasing in suburban and rural areas, check the region’s USDA eligibility. For perspective, about 97% of U.S. land mass is eligible and that figure comprises both rural areas and suburban neighborhoods.

 

In order to qualify, the homebuyer must make 115% or less of their area’s median income. When you check the area’s eligibility for USDA loans, also check local incomes. For instance, in an area with a $70,000-per-year median income, a homebuyer can make up to $80,500 annually and qualify for a USDA loan. Down payment rollovers are available here as well, with 1.0% of the loan amount due upfront, and 0.35% per year based on the current loan balance.

 

There are other programs available, but what if you want to make a large down payment and try to get yourself a better deal on your mortgage? You can, of course, just save up for a while. But if you have a new family, or need to move into a new city and feel like you would rather buy rather than rent for a few years, there are some other options available to you.

 

Tax laws allow you to withdraw up to $10,000 in IRA funds to buy your first home. If you’re married and you’re both first-time buyers, you each can pull from your retirement accounts, which means you could potentially put forth a $20,000 down payment without a tax penalty.

 

IRS definition of first-time homebuyer works out in your favor even if you’re not technically a first-time buyer. You don’t actually have to be purchasing your very first home. You qualify under the tax rules as long as you didn’t own a principal residence at any time during the three years prior to the purchase of the new home. Often, the penalty is waived for early withdrawal, but in some cases you may owe tax on that withdrawal depending on the type of IRA.

 

Speaking of taxes, if you receive a gift from a family member, that’s tax exempt up to $14,000 for both you and the giftor. If you receive a gift specifically for the purpose of a down payment, you need to go through the appropriate channels because, contrary to popular belief, a lender will actually reject your application if your down payment is a gift that’s not properly reported.

 

This usually involves a gift letter and then documentation of the gift as you receive and deposit it. It’s then up to you to report it to the IRS because your lender won’t do it.

 

You can also receive personal loans from family members for a down payment, and if this makes more sense in terms of interest and loan balance, then it might be the way to go (otherwise, you might just try an FHA loan).

 

For more perspectives on real estate, check back with us each week as we post new blogs and be sure to sign up for our Priority Access List for advance listings and market updates. We’ll see you next week, and in the meantime, don’t forget that you can also keep up with us on Facebook and Twitter!

 

Get It Right Solutions LLC

 

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