It’s not easy to scrape together enough cash for 20% or even 5% of your new home’s purchase price. Yet the fact remains that the more cash you pay upfront, the easier it can be to qualify for and close on a loan. Plus, your mortgage payments will be smaller – especially if you can put down 20% and avoid private mortgage insurance. This is because lenders often give incentives, such as better interest rates and reduced insurance needs, for paying down a large percentage.
While it may be difficult to imagine coming up with enough money, you do have several options when it comes to increasing your down payment.
How to Increase Your Down Payment
1. Set Up a Savings Plan
If you sit down and analyze your personal budget, you’ll likely find a few areas where you can reduce your expenses – and if you don’t yet have a budget, establishing one is your first step toward finding money you didn’t know you had to save.
Once you’ve decided how much you can spare from your monthly budget, play it safe by setting up an automatic transfer into a savings account that you’ve set aside for home-buying funds. Schedule your transfer as close as possible to payday to eliminate the urge to spend it.
2. Ask the Government
The government wants you to buy a house. Many of the federal down payment assistance programs like AmeriDream were victims of the Housing Administration and Recovery Act (HERA) in 2008, which banned down payment assistance programs for FHA loans.
However, some state and county programs are still alive and kicking. For example, California offers the CHDAP, or California Homebuyers’ Downpayment Assistance Program, which gives qualified home buyers a deferred-payment loan for up to 3% of the purchase price for the down payment, closing costs, or both. Check with your local government authority to see if similar programs exist in your area.
If you are a veteran or are still serving in the armed forces, you may qualify for a VA loan, which does not require a down payment. However, note that certain lenders will still ask for some money down, so you may need to shop around to find the right mortgage company.
3. Ask the Seller
In addition to paying the closing costs, some sellers are willing to help you out with the down payment in order to get a sale closed. This scenario usually includes a nonprofit third-party program as the vehicle, and entails the seller giving the amount of the down payment (along with a small fee) to the nonprofit, which then passes the funds on to the buyer. A list of approved nonprofit participants is posted on the HUD website.
In this scenario, the middleman is required because it’s illegal for sellers to directly hand the down payment funds to their buyers. Sellers can give lenders direct assistance with closing costs, but using this money for the down payment instead is also illegal. Note that because of HERA’s restrictions, as of 2008 such programs are only allowed for conventional loans and not FHA loans.
Also, be aware that IRS Revenue Ruling 2006-27 determined that these transactions are not considered tax-exempt. Ask your lender if they are willing to permit seller-funded down payment programs before you proceed.
4. Ask Mom and Dad
Your parents or grandparents might find it much easier than you to scrape together a few thousand dollars. If you decide to get family assistance, you will need to be very clear whether the funds are a gift or a loan. If you receive a loan from family or friends, draw up specific repayment terms, and if you receive a gift, keep in mind that parents can give up to $13,000 annually to their children without having to pay gift taxes.
5. Get the IRS to Help
While you may have a substantial income, you might still find it difficult to hold on to your money. In that case, a simple solution is to have the IRS hold on to it for you. Change your withholding exemptions to “0” (zero) on your W-4 form, which will force the IRS to take extra money from your paycheck. When tax time comes around, you’ll owe less in taxes or have a larger refund that you can immediately tuck into your home buying savings account.
6. Use Your Retirement Account
If you are a first-time home buyer, you can withdraw up to $10,000 from your IRA account without having to pay the usual 10% penalty tax for early withdrawals. However, you do need to pay the regular income tax on the withdrawal. Check with your CPA or read IRA Publication 590 to confirm that you qualify. You can also withdraw your contributions from a Roth IRA with no taxes or penalties to worry about.
401k plans are not eligible for this program, but you do have the option to roll some of your 401k funds into an IRA and then withdraw the $10,000 from this account, assuming you are in a situation that would normally allow rollovers. Ask your employer’s HR representative if your plan permits it. You may suffer a hit from federal income tax withholding unless you do a direct rollover into the IRA, so do your research first.
Another option is to simply borrow the money from your 401k. Because it’s a loan rather than a withdrawal, this does not trigger the early withdrawal tax penalty. However, your employer may require you to start repaying the loan immediately out of your paycheck, and you’ll likely need to repay the full amount within five years. Check with your employer’s HR department to find out what specific rules and requirements apply.
Even if you don’t plan on buying a house in the near future, it’s a good idea to start saving now. If you set aside a little money each month into a special savings account, you’ll be amazed to see how fast that fund grows. And if you decide not to buy a house at all, you can still use the account for other purposes: funding a dream vacation, buying a new car, or paying for an unexpected emergency.
What other methods can you suggest to come up with more money for a down payment?