Many home lenders after the 2008-09 financial crisis protected themselves by requiring a 20-percent down payment. But that’s loosened up the past few years.
In 2014, Fannie Mae and Freddie Mac, the largest government-sponsored enterprises (GSEs) and the biggest backers of home loans, began buying loans where borrowers made just a three-percent down payment. For a $300,000 home, that works out to a down payment of $9,000 ─ a sum that’s relatively much easier to save for than the $60,000 from a 20-percent loan.
Of course, a down payment of at least 20 percent relieves the borrower of carrying private mortgage insurance ─ part of the monthly loan payment that stays with the loan until 20-percent equity is achieved and protects the lender against the loan defaulting. Still, that 20 percent is a daunting amount that many buyers can’t afford.
While most Americans use their savings for a down payment, there are some lesser-known ways to find that crucial cash. Keep in mind, however, that they may come with hazards.
Loan from your 401(k): Yes, but risky
Did you know you can take money out of your 401(k) without an IRS tax penalty to help pay for a down payment on a home loan? You can borrow up to half your 401(k) balance ─ up to $50,000 ─ at any age or for any reason. And a down payment for a home loan is one of the few good times that tapping into your 401(k) before you retire makes sense. It’s also a good reason to start one early and maximize your contributions to take advantage of any company match.
After taking money out of your retirement account, you usually have to pay the loan back in five years or less, but some employers let you cover it over 15 years if you’re using the funds specifically to pay for a down payment on a home loan. Still, if you lose your job or change jobs, you must pay back the loan straight away or else it will be considered income on which you’ll owe tax.
Traditional IRAs and Roth IRAs: Yes
If you haven’t started contributing to a Roth IRA, here’s a good reason to start. You can withdraw all your contributions tax- and penalty-free, at any age. If you’re buying a home, you can withdraw the earnings you’ve made on your initial contributions, up to $10,000, as long as you’ve had the Roth IRA for five years ─ although you’ll end up paying taxes on the earnings, plus a 10-percent penalty.)
The IRS even recognizes that two are better than one, so your spouse can also withdraw the same amount tax-free for the down payment. Even if you haven’t had the Roth IRA for five years, you still can withdraw money, but you’ll just pay taxes on it, the IRS says.
Cash advances on credit cards: No
This simply doesn’t make sense for your down payment. The interest rate you’ll pay often is jarring. And maxing out your credit cards will hurt your FICO score and add debt to your all-important debt-to-income ratio, which can disqualify you for a home loan. Pay down your credit cards as much as you can instead.
Bank of Mom and Dad: Yes, but ...
Parents and relatives often can help out with a cash gift for a down payment. They can also tap their own IRAs and 401(k)s to help a family member. But get that $500 check from Uncle Ernie into your savings or checking account as soon as possible. Cash saving and gifts must be deposited in a bank account to be part of asset calculations. And it has to stay there for at least 60 days so lenders can account for the cash through at least two bank statement cycles. This is a process that lenders refer to as “sourced and seasoned.”
Bottom line: All cash has to be accounted for. Otherwise, it can be considered an undisclosed loan that could affect that debt-to-income ratio. And because of federal rules on money laundering, you won’t be able to bring physical cash (like mattress money) to the closing table. The cash element of the down payment must be in the form of a cashier’s check.
Before making any major financial decisions, discuss the various home-loan options with a licensed loan officer at loanDepot.
Published March 29, 2017
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