Down Payment Strategies for First-Time Home Buyers
Coming up with a down payment for your first home can be a challenge. While purchasing a home is often a good move financially speaking, putting down more than you can afford could impact your bottom line and your ability to repay your loan.
Here we provide some options of coming up with the down payment for your first home that you may not have considered.
Making Your Down Payment
Mortgages with Low Down Payments
While lenders prefer home buyers put down 20% of the home’s purchase price, there are other alternatives open to first-time home buyers that aren’t as costly up front.
FHA loans—Backed by the Federal Housing Administration, FHA loans allow for down payments as low as 3.5% of the home’s purchase price.
Conventional loans—This encompasses loans not backed by the government (that is, Freddie Mac and Fannie Mae) with first-time home buyer loans for as little as 3% down for those who have good credit.
VA loans—Guaranteed by the Department of Veterans Affairs, these loans have no down payment requirement.
USDA loans—These loans are backed by the Department of Agriculture. They also have no down payment requirement.
You may worry that putting down less money will mean higher interest rates and premiums. However, once you are in a home, you may be able to build equity faster than waiting to save for a higher down payment.
Conventional loans require monthly mortgage insurance when your down payment is less than 20%. FHA loans will always require payment of upfront mortgage insurance and monthly mortgage insurance regardless of the amount of your down payment. Payment of the funding fee is required (unless you are exempt) on all VA loans and this can be financed into your loan amount.
State & Local Down Payment Help
Depending on the state you live in, you could potentially obtain down payment assistance through the government, foundations, non-profits, and certain employers. This is usually in the form of a zero-interest forgivable loan or a grant. These programs can target an entire state or a very specific neighborhood.
Often, such assistance with your down payment is paired with lower mortgage interest rates or tax breaks. Those looking to apply may need to take certain classes designed for first-time home buyers to prepare them for homeownership.
While these programs are worth looking into for first-time home buyers, many programs will have a maximum sale price on the home to be purchased and/or limits on income.
Help for Your Down Payment from Family
You may be surprised to hear that more than a quarter of home buyers under the age of 28 made use of a gift from a relative or friend to help with their down payment.1
While this is entirely legal and acceptable to lenders, you will need certain documentation from the donors to establish that they are financially capable of making such a donation. This will entail offering the lender bank statements as well as proof that the donation is not a loan but rather a gift.
Using Retirement Savings
Some first-time home buyers attempt to fund a down payment by withdrawing from their retirement account. This can have different repercussions depending on the type of retirement account, assuming those who are withdrawing funds are under the age of 59 ½. (This is for informational purposes only and is not intended to be tax or accounting advice. Please consult your tax or accounting advisor for additional guidance.)
For employer-sponsored 401(k) plans, withdrawals are allowed generally, but income taxes on this money must be paid plus a 10% tax penalty for early withdrawal. If your particular plan allows for a loan, you will have to repay this money with interest to avoid paying income taxes and a penalty.
Some 401(k) plans require five or more years to pay back a loan for a first home. Should you leave your job, the loan needs to be paid back or rolled into an eligible retirement account before the next deadline to file taxes. Otherwise, taxes must be paid on the money borrowed, plus a penalty.
Those with a traditional IRA can generally make withdrawals up to $10,000 for a first-time home purchase. The money taken out will be taxed, but no penalty is involved as long as the money is used to buy or build a first home.
In addition, withdrawals from Roth IRAs are tax-free and there is no penalty included for buying a first home so long as the account holder has had the account for at least five years.
As you might imagine, the downside to withdrawing from your retirement savings is that it can take many years to replenish the funds. You should always consult with a tax or accounting professional before you move forward.