Is a lack of down payment holding some people back from buying a home? That seems to be true, as coming up with the down payment is the #1 reported obstacle to homeownership according to various surveys, especially with Millennials and younger buyers. (We covered the current state of down payments in real estate in part one of this blog.)
But their perception may also not match the reality of what’s needed to buy. In fact, a 2015 survey conducted by Ipsos Public Affairs found that 36% of those surveyed thought that a down payment of 20% was necessary to buy a home.
But that’s far from the case these days. In fact, according to Freddie Mac, about 40% of all homebuyers put down less than 10% on the overall value of their homes.
In part one of this blog, we covered 25 facts and stats about down payments and home buying. So, when it comes to amassing a down payment so you can purchase your dream home, here are five alternative ways to come up with the cash to close:
1. Ask the seller to finance a piece of the mortgage
Although it’s not as common anymore, it’s not unheard of that the seller will carry a small portion of the new mortgage for you, in the form of seller financing.
Let’s present an example, which is strictly a hypothetical for illustration purposes. A home buyer is interested in a $500,000 home. They’re approved for a $450,000 first loan (90% Loan-to-Value) but still need $50,000 to bring in for a down payment. Maybe our seller only has $25,000 available in the bank liquid at that time. What can they do?
Why not present an offer to the current homeowner for seller financing? That needed $25,000 would be lent from seller to buyer, just like any other mortgage loan, except in this case, the seller assumes the role of the bank or lender.
So why would our seller do this, in the first place? $25,000 is not a huge amount in the grand scheme of things, and if meant that they could close this deal and sell their home (especially in a soft market or if they haven’t received many other offers), then it’s in their best interest, too. Of course, the whole seller financing deal would be set up with legal paperwork, so they’re protected. The seller would probably also earn a nice profit with a higher-than-usual interest rate on the loan.
It doesn’t hurt to ask about seller financing!
2. Borrow from your retirement funds
Let’s say that you’re buying a luxury or high-end home, but you don’t quite have enough funds for the big down payment, maybe because your funds are tied up in investments or their business. Another option for some qualified buyers is to use some of their retirement accounts as a down payment. Of course, you don’t want to do this without consulting your financial advisor and even getting a second opinion, but for some buyers, it’s an option that makes the most sense.
The rules, guidelines, and penalties vary widely, but some 401(k) plans allow you to take out 50% of the vested balance (with a $50,000 limit) as a loan. This loan is tax-free, does need to be repaid back to the 401(k) within a certain timeframe, like five years.
Do you still need help coming up with a little bit more for your down payment? You may also be able to take up to $10,000 from your traditional IRA account without being stung by the typical 10% penalty. However, it’s not a perfect option, as you may have to pay taxes on the amount you withdraw. Again – consult your financial planner, investment administrator and your CPA before using retirement funds for a down payment!
3. Borrow from family:
Far more prevalent among today’s home buyers, family members are often giving loans or outright gifts to their sons, daughters, and kin in order to fund a home purchase. However, if you want to do this, it’s not enough to get the loving donation from your family, as we need to carefully document everything for the lender as well as the real estate side of the transaction. But done correctly, this is a great way to give a first-time homebuyer or young couple a chance to finally own – and avoiding paying rent!
4. FHA loans are a perfect low-down payment option:
If you’re looking for a mortgage on your first home and you don’t have a big down payment saved, a Federal Housing Authority (FHA) loan may be the perfect option. Insured by the government, FHA loans allow as low as a 3.5% down payment, are open to borrowers with less than ideal credit scores and have special allowances for gifting funds and other creative solutions. There are some drawbacks, like mandated mortgage insurance, but FHA loans are tailor-made for people without the funds to put more down on a home, but otherwise qualify.
5. Utilize secondary financing:
This is a broad group to describe several different loan options, but they all have one thing in common: they involve a second loan to close the real estate purchase. This loan can be from some external source of funding, or it can be a structured home loan that is part of the home purchase financing. In that case, it would be subordinate to any first home loans used to finance the property.
Here are some of the different options under that wide umbrella:
- Home equity line of credit (HELOC) on another property,
- Business loan,
- Personal loan,
- Cash-out refinance on a rental property or an existing home before you sell it.
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While coming up with the funds for a down payment may seem daunting at first, these are just a few of the great solutions available to home buyers these days. Contact me if you’d like to discuss your options and see what kind of loan you’re qualified for – you may be pleasantly surprised!