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How To Afford a Home Loan Down Payment

When buying a house, coming up with a down payment for a home loan can be difficult. Using home equity from another property isn't helpful for first-time homebuyers. If you don't own real estate, it's much harder to come up with money to meet the down payment requirements for a conventional loan.

Most lenders require a minimum down payment that ranges between 5% and 20%, which adds up to quite a chunk of change. The lower your down payment, the fewer your mortgage loan options. Your monthly mortgage payment, mortgage rate, and closing costs could also be higher.

Here are some ways a cash-strapped buyer, especially a first-time homebuyer, can accumulate enough money for an upfront down payment on a home.

Use Money From Your Individual Retirement Account (IRA)

The IRS allows first-time homebuyers to use money in an IRA account to purchase a house. A first-time buyer is a person who has not owned a principal residence during the previous two years. The account holder, a spouse, children, grandchildren, or a parent can use up to $10,000 toward a down payment.

If married, each spouse can take up to $10,000 from their IRA account. The $10,000 is a lifetime limit that the borrower must use within 120 days of the withdrawal. These limits are subject to change, and there can be tax penalties for excessive borrowing from a retirement account. Make sure you consult with an accountant before you touch your IRA.

Borrow From Your 401(k)

Many companies' 401(k) plans allow employees to borrow from the plan. Each plan has different terms, but the IRS prohibits a loan from exceeding 50% of the vested value of the balance or more than $50,000. Make sure to check with an accountant first so you can avoid any potential tax penalties.

As long as the repayment of a loan and interest occurs within a "reasonable" time, the employer may determine the:

  • Minimum loan amount
  • Repayment terms
  • Interest rate on the loan
  • Applicable fees

A borrower may have to pay off the loan balance immediately if their employment with a company terminates prior to paying off the loan.

Use Gifts if Available

Another source of a down payment is from a gift. The IRS' gift limit allows a person to give a non-spouse the maximum gift amount for the year without incurring a gift tax. As of 2024, a person may give up to $18,000 per year, per person. Make sure to check the IRS website for updated figures each year.

The gift giver should provide the lender with a written letter confirming that:

  1. The money was a gift, and
  2. Repayment is unexpected.

Most lenders view gifts from parents and grandparents with less scrutiny than a cash gift from a friend or distant relative.

Borrow From a Friend or Relative

If you don't have enough cash to make a down payment for a home loan, consider asking friends and family to float you a loan. Friends and family are a good source for a down payment loan because the lending terms are often more flexible than a traditional bank loan.

A bank lender, however, will factor the friendly loan into the overall debt the borrower owes to creditors. This may reduce the amount of a home loan that a borrower can qualify for. If the friend or relative requires little or no payment, the debt-to-income ratio may be unaffected.

Every lender has different guidelines for approving friendly lending plans. A lender may require that the borrower:

  • Pay the market interest rate on the friendly loan for a certain term
  • Pay at least 5% of the purchase price of the home or half of the down payment amount from their own reserves

Of course, you should be careful about borrowing from acquaintances or family members. Money can strain relationships and evaporate trust. Sometimes existing tension between loved ones can make financial planning even more difficult. Many people choose to keep their personal finances completely separate for this reason, especially for a first home or primary residence.

Invest Together

Sometimes, a joint investment in a property will benefit all parties involved. But you have to make sure you can trust your co-investors. You must also ensure that a fair agreement can be reached for both people involved.

This is an effective way to invest in a home if:

  1. One person plans to contribute cash, and
  2. The other person plans to live in the house.

When the property is sold, both parties share the equity interest.

Keep in mind that money can ruin friendships and family relationships. While homeownership can be rewarding, joint homeowners have to share responsibility. The home-buying process can tie your credit scores together no matter the type of mortgage you take out. You'll both be responsible for paying off the home's purchase price and mortgage interest over time.

Apply for a Home Loan Down Payment Assistance Program

Various government programs exist to help buyers in all income brackets purchase a house. Because a down payment is the largest and most difficult barrier first-time buyers face, the federal government and many state and local governments have down payment assistance programs. For example, service members may qualify for Veterans Affairs VA loans with more favorable terms. Similarly, rural property owners may qualify for U.S. Department of Agriculture USDA loans with zero-down or lower down payment requirements.

The Federal Housing Administration (FHA) supports two types of loan down payment programs:

  • Nonprofit assistance programs
  • State, county, and city programs

Nonprofit programs provide down payment grants, while local and state programs offer second mortgages. To participate in any of the programs, a buyer must use an FHA loan. Check out the Housing and Urban Development (HUD) website for more information.

The nonprofit or the government's ability to finance the homebuyer program determines whether the program continues. Programs often change, so it is important to check regularly with nonprofit agencies and federal, state, and city governments for eligibility requirements and funding status. A loan officer will also be able to give you more information on:

  • Your preapproval odds based on a mortgage calculator
  • Minimum credit score requirements
  • Other low down payment requirements for such mortgage programs

Use a Second Mortgage for a Home Loan Down Payment

Some lenders may offer a borrower a second mortgage to finance a down payment. A second mortgage will eliminate the cost of paying private mortgage insurance (PMI). Most lenders require a borrower to pay private mortgage insurance when a down payment is less than 20%.

A second mortgage has some potential disadvantages, including:

  • A higher interest rate than a first mortgage and possibly a balloon payment, or
  • A lump sum payment at the end of the term.

In a rising real estate market where home values increase, the disadvantages are often irrelevant. This is because a borrower may refinance the second mortgage into the first when the house has increased in value. If, on the other hand, the real estate market has little growth, paying a lump sum at the end of the loan term may be difficult.

Use the Equity from a Different Home

Selling an existing home for more than its mortgaged value will yield equity that a buyer can use for a down payment. For example, suppose a buyer owns a home worth $500,000 and only owes the lender $400,000. Here, the buyer can use the remaining $100,000 for the down payment on another house. This method is particularly relevant in a strong real estate market. In a real estate market with slow growth, a home may take more time to rise in value.

Maximize Savings

If all else fails, one of the best ways to finance a home's down payment is to save the money. This, of course, can be difficult since most people do not typically have thousands of dollars in the bank. However, a potential buyer can find ways to maximize the money they save. Consider:

  • Paying off credit cards
  • Getting a second job
  • Selling unused items
  • Cutting unnecessary bills or monthly subscriptions
  • Avoiding eating out often
  • Reducing purchases of luxury items

Sometimes, these simple steps can help generate the money needed for a home loan down payment.

A Lawyer Can Help You Find Your New Home

Moving into your dream home with your family members may be a lofty goal. But it doesn't have to be impossible. A real estate lawyer can help you explore different kinds of loan programs and mortgage lenders to make your dream a reality. They can also provide legal advice that your real estate agent or realtor might be unable to provide.

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