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Finding a Home Loan Down Payment

When buying a house, coming up with a down payment for a home loan can be difficult. Most lenders require a down payment that ranges between 5 and 20 percent, which adds up to quite a chunk of change. Here are some ways that a cash-strapped buyer, especially a first time home buyer, can accumulate enough money for a down payment on a home.

Use Money from Your IRA

The IRS allows first time home buyers to use money in an IRA account to purchase a house. A first time buyer is a person that has not owned a principle residence during the previous two years. The account holder, a spouse, children, grandchildren, or a parent can use up to $10,000 toward a down payment. If married, each spouse can take up to $10,000 from his or her IRA account. The $10,000 is a lifetime limit that the borrower must use within 120 days of the withdrawal.

Borrow from Your 401K

Many companies' 401K plans allow employees to borrow from the plan. Each plan has different terms, but the IRS prohibits a loan from exceeding 50 percent of the vested value of the balance or more than $50,000. As long as the repayment of a loan and interest occurs within a "reasonable" time, the employer may determine the minimum loan amount, the repayment terms, the interest rate on the loan, and the applicable fees. A borrower may have to pay off the balance of the loan immediately if their employment with a company terminates prior to paying off the loan.

Get a Gift

Another source of a down payment is from a gift. The IRS' gift limit allows a person to give a non-spouse the maximum gift amount for the year without incurring a gift tax. Any person may give up to $13,000 per year, per person. The gift giver should provide the lender with a written letter confirming that the money was a gift and repayment is unexpected. Most lenders view gifts from parents and grandparents with less scrutiny than a cash gift from a friend or distant relative.

Borrow from a Friend or Relative

If you don't have enough cash on hand to make a down payment for a home loan, considering asking friends and family to float you a loan. Friends and family are a good source for a loan because the lending terms are often more flexible than a traditional bank loan. A bank lender, however, will factor the friendly loan into the overall debt the borrower owes to creditors. This may reduce the amount of a home loan that a borrower can qualify for, but if the friend or relative requires little or no payment, the debt-to-income ratio may be unaffected.

Every lender has different guidelines for approving friendly lending plans. A lender may require that the borrower do the following:

  • Pay the market interest rate on the friendly loan for a certain term
  • Pay at least 5 percent of the purchase price of the home or half of the down payment amount from their own reserves

Invest Together

Sometimes a joint investment in a property will benefit all parties involved. This is an effective way to invest in a home if one person plans to contribute cash and the other person plans to live in the house. When the property is sold, both parties share the equity interest.

Apply for a Home Loan Down Payment Assistance Program

Various government programs exist to help buyers in all income brackets purchase a house. Because a down payment is the largest and most difficult barrier faced by first time buyers, the federal government and many state and local governments have down payment assistance programs. The Federal Housing Administration (FHA) supports two types of down payment programs -- nonprofit assistance programs and state, county, and city programs. Nonprofit programs provide down payment grants, while local and state programs offer second mortgages. A buyer must use an FHA loan to participate in any of the programs.

The nonprofit or the government's ability to finance the program determines whether the program continues. Programs change often so it is important to check regularly with nonprofit agencies and federal, state, and city governments for eligibility requirements and funding status.

Use a Second Mortgage for a Home Loan Down Payment

Some lenders may offer a borrower a second mortgage to finance a down payment. A second mortgage will eliminate the cost of paying private mortgage insurance (PMI). Most lenders require a borrower to pay private mortgage insurance when a down payment is less than 20 percent. A second mortgage does have some potential disadvantages, including a higher interest rate than a first mortgage and possibly a balloon payment, or a lump sum payment, at the end of the term. In a rising real estate market, the disadvantages are often irrelevant because a borrower may refinance the second mortgage into the first when the house has increased in value. If, on the other hand, the real estate market has little growth, paying a lump sum at the end of the loan term may be difficult.

Use the Equity from a Different Home

Selling an existing home for more than its mortgaged value will yield equity that a buyer can use for a down payment. If a buyer, for example, owns a home that is worth $500,000 and only owes the lender $400,000, the buyer can use the remaining $100,000 for the down payment on another house. This method is particularly relevant in a strong real estate market. In a real estate market with slow growth, it may take more time for a home to rise in value.

Last Resort, Save the Money

If all else fails, one of the best ways to finance a home's down payment is to save the money. This, of course, can be difficult since most people do not typically have thousands of dollars in the bank. However, a potential buyer can find ways to maximize the money they save. Consider paying off credit cards, getting a second job, or selling unused items. Sometimes, these simply steps can help generate the money needed for a home loan down payment.

Next Steps
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