Coming up with a down payment can be a significant obstacle for potential homebuyers seeking to take advantage of what are still low prices and mortgage rates. If you're having that problem, here are several options you might not have considered that can help you meet the down payment requirement for a mortgage loan.
We'll skip the obvious ones, such as taking money out of savings or selling stocks or other investments. If you could do that, you wouldn't be having difficulty coming up with a down payment. But here are some realistic possibilities:
1 - Government-backed mortgages
Everyone knows that you can get a VA loan if you're a veteran or member of the military, but did you realize that VA loans require no down payment in most cases? Better yet, that you're not penalized with a higher interest rate or by having to pay for mortgage insurance just because you put no money down?
VA mortgages are guaranteed by the government, which essentially replaces the need for a down payment, as far as the lender is concerned. So you can get a comparable rate to your civilian friends who put 20 percent down on a conventional mortgage.
If you don't qualify for a VA loan, there are two other government-backed mortgages you might consider. FHA mortgages can still be obtained with as little as 3.5 percent down, meaning you can buy a $150,000 home if you can cobble together just over $5,000 (closing costs can usually be rolled into the loan itself). Furthermore, there are no hardship requirements or income limitations that might exclude you from qualifying.
A third, often overlooked, option is a USDA rural development loan. These are mortgages for low- and moderate income borrowers that, like a VA loan, can be obtained with no money down. However, you do need to be able to demonstrate that your current housing is inadequate and the loans can only be used to buy homes in rural areas and smaller communities. Not all lenders offer these, however, so your choices there may be limited and the limited funding for the program means you may have to go on a waiting list.
2 - Tap a retirement account
You can take money from either an IRA or a 401(k) account to obtain money for a down payment for a home purchase. With an IRA, you can withdraw up to $10,000 if you're a first-time homebuyer, $20,000 if it's a joint account with your spouse. There's no penalty for early withdrawal in this situation, although the money withdrawn is taxable unless it's a Roth IRA account you've had for at least five years.
You can also borrow money from a 401(k), provided your employer will allow it. There's no penalty for early withdrawal if you take it as a loan, though you do have to pay it back within five years, plus interest. However, the interest is paid back into your 401(k) account (you're basically paying yourself), so that's a wash (unless the money would have generated a higher return by staying in your account). If you don't pay it back in time, though, you'll have to pay a penalty for early withdrawal unless you were at least 59 ½ at the time you took it out.
3 - Family assistance
Many young people receive help from their parents in buying a home, often in the form of a gift to cover part or all of the down payment. This is perfectly acceptable, but lenders will want to see proof that the money is actually a gift and not a loan. This is usually done in the form of a gift letter, which specifies the amount and purpose of the gift, and the relationship of the giver to the recipient (they have to be immediate family). Often, the money is simply treated as an advance on an inheritance.
If your parents aren't in a position to give you that much money outright, another possibility is to pledge certain securities or other investments as collateral toward the mortgage until you build enough equity to refinance on your own. This lets them keep the money and continue to benefit from any return on the investment while at the same time securing a mortgage for you.
The downsides are that they can't sell or trade the securities while they're pledged, and that they could lose their investments if you default on the loan. You may need to work with a community banker or other small lender to make this type of arrangement.
4 - Employer assistance
Some employers offer programs to help their employees come up with the money for a down payment and/or closing costs, often in the form of a low-interest loan. These are most commonly offered by larger corporations or public employers such as government agencies or public universities. However, since these are often in the form of a second mortgage secured by the home, you may still need to come up with part of the down payment yourself. In that case, the main purpose of the assistance will be to avoid paying for mortgage insurance, charged on loans with less than 20 percent down.
4 - Home equity
This may look absurd at first glance but you most certainly use home equity as a down payment - to buy a second home. If you've got $160,000 in equity in your primary home and are looking to buy a vacation property for $200,000, you should be able to borrow $40,000 against the equity in your first home to make a 20 percent down payment on the second.
There are several ways to do this. The first would be to do a cash-out refinance of your first home, borrowing $40,000 in the process. This works particularly well if you can lower the rate on that mortgage in the process. Another possibility would be to take out a home equity loan for $40,000. You'll pay a higher interest rate than you would with a cash-out refinance, but only on the $40,000 borrowed and your closing costs will be less than they would be on a complete refinance.
6 - Down payment assistance programs
Many states offer programs designed to help potential homebuyers come up with the money for a down payment. These are sometimes tied to people buying homes in certain areas, or those working in certain professions, such as teaching or public safety. Some larger cities offer them as well. Check with your state housing agency or the housing authority in your city to see if they have any programs you might qualify for.