By Marilyn Lewis of MSN Real Estate
If you’re hoping to buy a home to take advantage of cheaper home prices and attractive mortgage interest rates, your first question may be: "Where do I find money for a down payment?"
Below is a list of workable ideas and those to avoid. We gathered expert advice from Bill Banfield, director of capital markets for Quicken Loans; Jeffrey J. Belonger, manager with Infinity Home Mortgage Co. in Cherry Hill, N.J.; and EJ Hawkins, counselor with ClearPoint, a national nonprofit credit counseling service.
First, a few tips:
- Check with your bank or mortgage broker that the source of your down payment is approved in your loan’s rules.
- Ask real-estate agents about state and local housing incentives, grants and loans and what local lenders offer.
- Some down-payment ideas are safer than others; a few have toxic consequences to your taxes or retirement savings. Study your options carefully and review your plan with a certified public accountant or a nonprofit housing counselor approved by the Department of Housing and Urban Development (find one here or call 1-800-569-4287).
- Keep a paper trail of every move so you can document, for your lender or the tax man, each income source, asset sale and transaction.
- Be wary of mortgage fraud. The scam you’re most likely to encounter is when a mortgage professional suggests inflating the price of a house in order to kick back cash to you for closing costs. It sounds tempting, but you’d be getting fleeced by overpaying for the house and you could face jail time if you participate. Report crooked players to your state attorney general’s office (find yours here).
Here is a list of ideas for scraping together your down payment.
Low-risk sources of cash
1. Pull from savings: The time-honored way to fund a home purchase is to set aside money each month. Use an automatic electronic transfer through your bank or credit union. Choose an account that that earns the most interest possible while letting you access the money. Review account types and learn how to "ladder" certificates of deposit by reading this article.
2. Liquidate miscellaneous assets: Sell your nice car, buy a beater and apply the difference to your down payment. Sell your boat, motorcycle, collectibles or other assets. Use your tax refund. Call in money that people owe you.
3. Sell stock options: If stock options are part of your compensation, selling them might earn you cash. Contact your human-resources department to learn the rules.
4. Sell taxable investments: Sell stocks, mutual funds, bonds and other taxable investments before touching money held in tax-deferred retirement accounts, such as 401(k)s and IRAs, which require you to pay significant penalties when you sell.
5. Cash in a life-insurance policy: So-called permanent life insurance policies (not "term" policies but "universal" or "variable universal life" or "whole life" policies) grow in value as you pay into them. When enough value has accumulated, you can take cash out or borrow against them. Talk with your insurance agent to learn your options.
Caution: If you no longer need the insurance, this could be a nice source of ready cash. But first-time homebuyers usually are young, have children and need the protection of insurance; withdrawing money from a policy could reduce or eliminate your death benefit, leaving your family in financial trouble if you die. You also can lose coverage if you borrow against the policy but don't pay it back. Ask your insurance agent to outline the pros and cons. Call your state's insurance commissioner's office if you have questions. (Find yours with this map.)
Friends, family and employers
6. Use a gift: Some mortgages – loans insured by the Federal Housing Administration, for example – let you apply gifts from immediate family members toward your down payment. You’ll need a "gift letter" from the person who gave you the money, verifying that it doesn’t have to be repaid. Be prepared for the lender to ask for copies of checks or wire transfers.
7. Try your employer: Some corporations, universities and local and state governments have programs to provide employees with down-payment assistance. Check with your human-resources department. For example, in South Dakota, 19 employers participate in a state-sponsored Employer Mortgage Assistance Program that lets employees take out a 2% interest rate second mortgage for $600 to $6,000 to cover closing costs and down payment. Each year, the city of Baltimore and state of Maryland contribute as much as $6,000 to 100 city employees (PDF) to help them buy homes within the city. These programs are meant to help keep valued employees in their jobs and closer to work.
8. Enlist a partner: A co-owner can help by sharing costs, including the down payment, and by signing on to be responsible for repaying the loan if you can’t quite qualify for a mortgage. A lender can explain the details.
Investigate government programs
9. State grants and loans are a potentially useful but constantly changing pool of down-payment money distributed through local and state agencies. Usually, these require a government-insured FHA mortgage. Funds are usually claimed quickly and programs expire or change frequently. Act early to be considered, or add your name to a waiting list. Find programs near you using HUD's state listings: Click your state’s name, then click "assistance programs."
Caution: Don't get roped into paying for "help" to obtain government grants and loans. Scammers and middlemen offer to guide you or qualify you for a fee, but you’ll get safer, cheaper advice from a HUD-qualified housing counselor.
Negotiate — with everybody
If you can save or even eliminate closing costs — which run roughly $5,000 to $8,000, depending on where you live — you can free up precious cash for your down payment. Although a seller can’t fund your down payment, the law lets buyers accept help with closing costs. Using an FHA loan, you can accept up to 6% of your home's purchase price toward your closing costs, although the FHA has explored dropping that to 3%. Conventional loans limit the help you can accept to 3% of the price if your down payment is 10% or less; it's 6% with a down payment of more than 10%. Your seller, lender or real-estate agent can help with closing costs. These parties occasionally will kick in to help a cash-poor buyer get a deal done. Here’s how:
10. Your lender: Buyers occasionally persuade lenders to forgo part of their "origination" fee and contribute it toward the closing costs, Hawkins says. The lender gets a smaller fee but the deal still puts money in the lender’s pocket. Another option: The lender might be willing to sell you a higher interest rate in exchange for helping you. In this case, the lender rolls the closing costs into your interest rate and you pay them as part of your monthly mortgage payment instead of as an upfront chunk of cash.
Caution: Depending on how long you keep the home, paying a higher interest rate than necessary could, over a loan’s lifetime, cost more than the down-payment help is worth. Find a nonprofit housing counselor to help you calculate if this is worthwhile.
11. Your seller (including builders): Buyers have a lot of leverage with sellers today, at least in some parts of the country.
- Ask your real-estate agent to help you search for sellers who are offering to cover closing costs. - Propose that the seller help with closing costs when you’re negotiating price.
- Sellers sometimes will sweeten the deal by purchasing discount "points" that lower your interest rate, letting you use more of your cash for the down payment. Each point costs 1% of the loan amount and can be used to reduce your rate by 0.125 to 0.25 percentage points. (If your mortgage was for $150,000, the seller might buy one point, for $1,500, potentially lowering your interest rate from 5.25% to 5%.) This would lower your monthly payment from $828 to $805.
Caution: Pushing a seller too hard to lower the price and make other concessions could ruin the deal. Be prepared for the seller to ask for a higher purchase price in exchange. Then the question is: Will the appraiser find the home worth the higher price?
12. Seller financing: Infrequently, a seller may be willing to act as your banker. It might be possible to strike a no- or low-down-payment deal with a seller who owns the home free and clear. But if the seller has a mortgage, you’ll need to qualify for a loan just as you would with a bank, including a down payment.
13. Your real-estate agent: Agents don’t like to admit it, but occasionally some will give up a portion of their several-thousand-dollar commission to keep a sale from falling through. Approach this conversation with tact and care.
14. Your new employer: Your leverage with an employer is never better than when you are first signing on. Depending on the company and how badly your skills are needed, you might be able to negotiate a contribution toward your down payment as part of your benefits package, as a signing bonus or in place of a relocation allowance.
Tap your retirement savings
Yes, you can cash out retirement accounts. But don’t do it. The ground lost in saving for retirement isn’t worth it. Also, the Internal Revenue Service penalties for removing cash from a tax-protected account before you retire are steep.
However, here are two less expensive (but still ill-advised) ways to leverage your retirement savings:
15. Tap your IRA. There’s an exception to penalties on withdrawals from retirement accounts that lets first-time homebuyers withdraw up to $10,000 from an IRA to use as a down payment on a home purchase.
Caution:
- Remember to declare the income on your taxes (you were excused from paying tax on it when you put it into the IRA, remember?)
- Be sure to chat with your accountant before doing this.
12. Seller financing: Infrequently, a seller may be willing to act as your banker. It might be possible to strike a no- or low-down-payment deal with a seller who owns the home free and clear. But if the seller has a mortgage, you’ll need to qualify for a loan just as you would with a bank, including a down payment.
13. Your real-estate agent: Agents don’t like to admit it, but occasionally some will give up a portion of their several-thousand-dollar commission to keep a sale from falling through. Approach this conversation with tact and care.
14. Your new employer: Your leverage with an employer is never better than when you are first signing on. Depending on the company and how badly your skills are needed, you might be able to negotiate a contribution toward your down payment as part of your benefits package, as a signing bonus or in place of a relocation allowance.
Tap your retirement savings
Yes, you can cash out retirement accounts. But don’t do it. The ground lost in saving for retirement isn’t worth it. Also, the Internal Revenue Service penalties for removing cash from a tax-protected account before you retire are steep.
However, here are two less expensive (but still ill-advised) ways to leverage your retirement savings:
15. Tap your IRA. There’s an exception to penalties on withdrawals from retirement accounts that lets first-time homebuyers withdraw up to $10,000 from an IRA to use as a down payment on a home purchase.
Caution:
- Remember to declare the income on your taxes (you were excused from paying tax on it when you put it into the IRA, remember?)
- Be sure to chat with your accountant before doing this.
16. Borrow from your 401(k): Most companies let employees borrow from the balance of their 401(k) accounts. Rules vary but, generally, you can extract as much as half of the vested amount in the account, up to $50,000. As you repay it, the money, including the interest, goes back into your 401(k). The plan administrator at your workplace can outline the specifics, including how long you’re given to repay the loan.
Caution:
- As long as you repay the loan, you won’t be taxed on the money until you withdraw it in retirement; unlike a mortgage loan, the interest you pay on this loan is not tax-deductible.
- As with the IRA withdrawal, this is considered a bad idea because it sets back your retirement progress.
- If you leave the employer for any reason before repaying the loan, you’ll have to repay the entire thing at once. Don’t say we didn’t warn you.
Caution:
- As long as you repay the loan, you won’t be taxed on the money until you withdraw it in retirement; unlike a mortgage loan, the interest you pay on this loan is not tax-deductible.
- As with the IRA withdrawal, this is considered a bad idea because it sets back your retirement progress.
- If you leave the employer for any reason before repaying the loan, you’ll have to repay the entire thing at once. Don’t say we didn’t warn you.
Dead-end options to avoid
You may have heard from friends and family about other strategies. Chances are, changing rules or interest rates have made them less effective. Don’t waste much, if any, time pursuing these:
1. Peer-to-peer lending: Websites such as Prosper.com and Lending Club essentially create a marketplace for people to directly lend and borrow money. The idea is that the lenders reap interest, borrowers get cash and the site collects fees. But Prosper, for one, has not funded one down-payment loan in the last year. CEO Chris Larsen speculates that's because piling a down-payment loan on top of a mortgage is unwise and unlikely to attract Prosper lenders.
2. The American Dream Downpayment Act was a federal program of grants up to $10,000 to first-time buyers, but no longer is offered.
3. Private nonprofit gift programs: Until late 2008, a special category of seller-funded nonprofit programs was able to channel up to 6% of the purchase price of a sale as a "gift." Federal law now prohibits seller-funded down-payment assistance, which means that programs run by AmeriDream, the Nehemiah Program, GAP, Homes for All and RealtyAmerica have all been closed.
4. Section 8 homeownership vouchers: Low-income buyers may be able to get help through this federal program, but you and the property must meet the qualifications. "The unfortunate part of the program is that there are too many variables involved," Hawkins says. "In all my (10) years in real-estate and financial counseling, I’ve only seen it used one time."
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