Get Money for a Down Payment
Whether you’re purchasing an existing home, building a new home or planning to fix up an older home, you’re probably excited about the prospect of closing the deal and moving in.
Not so fast. Buying a home is an expensive proposition – the biggest investment that most families ever make. While you aren’t required to cover the entire purchase price up front, you do need most times to come up with a down payment before you can close on your home.
The Biggest Closing Cost of All
Most line items are small change compared with probably the biggest closing expense of all: your down payment. This is because your down payment is a key part of the offer you present to the seller. The general rule of thumb is simple: the larger the down payment, the stronger the offer. More precisely: the greater the down payment’s share of the total purchase price, the more likely the seller is to accept.
Tips and Tricks to Save
1. Determine Your Expected Down Payment and Timeframe
First, figure out about how big your down payment will be.
Down payment size is a function of three overlapping factors: your desired initial loan-to-value (LTV) ratio, your time horizon (when you want to buy), and local housing market conditions. When people talk about budgeting for a future home purchase, they generally refer to list prices: “We’re willing to pay $300,000,” or “We can afford $250,000, but no more.”
However, on the matter of affordability, the most important number is the down payment amount. If you can’t cobble together a $50,000 down payment on a $250,000 house (or a $400,000 house, if you’re putting down less than 20%), then you can’t really afford the house.
Lastly, don’t completely deplete your bank account to buy your dream home. It’s wise to have at least three months’ income in liquid savings as an emergency fund, regardless of your near- or long-term goals. Six months is even better.
2. Shrink Your Required Down Payment With a Special Loan
If you’re looking to buy on an accelerated timetable, live in an expensive housing market, or doubt your ability to save for a 20% down payment on an acceptable house in your target neighborhood, look into special loan programs with lower down payment requirements.
Beyond program-specific requirements, these special loans have some important drawbacks. Perhaps most importantly, they carry Private Mortgage Insurance (PMI) premiums until LTV reaches 78% (though you can formally request PMI removal at 80% LTV).
3. Take Advantage of LHFS Down Payment Assistance Programs
Relatively few prospective homeowners realize that they could qualify for national down payment assistance programs that can reduce their out-of-pocket down payment costs by thousands of dollars.
4. Pay Off Outstanding Credit Card Debt
For many folks, paying off credit card debt is a high-priority goal. Even the low APR Credit Cards usually charge interest rates north of 10% APR. On an average balance of $1,000, that’s $100 in interest charges each year. If your debt load is higher, adjust accordingly.
Paying off credit card debt isn’t always straightforward, though. Focus on your highest-interest debt first, even if that means putting as little as $25 or $50 extra toward your payment each month. As your high-interest debt load shrinks, you can move onto lower-interest credit card debt, and you’ll likely accelerate your progress toward a $0 balance. With lower (or no) interest charges eating into your spending and saving power, you can then direct your dollars toward your down payment fund.
5. Set Aside a Portion of Your Tax Refund
Expecting a tax refund this year? Reserve a slice of it to reward yourself for all your hard work last year – a nice restaurant meal, a frugal weekend getaway, a new piece of furniture for your home. Enjoy it.
Then sock the rest of your refund away in your down payment fund. If you reliably receive a $3,000 refund, spend $1,000, and save the rest, you’ll have $6,000 after three years, and $10,000 after five. That probably won’t account for your entire down payment, but it can’t hurt.
6. Make Recurring Savings Deposits
Knowing you need to set money aside each month is one thing. Actually doing it is another. Set yourself a calendar reminder on the same day each month or pay period to transfer a set amount of money – at least 5% of your take-home pay, and ideally 10% – into your primary savings account. You can then separate the share allotted to your down payment from your general savings or other savings goals. Or, better yet, create a separate savings account whose sole purpose is to hold your down payment funds.
7. Automate Your Savings Deposits
What’s even better than recurring savings account deposits? Automated savings account deposits that you don’t have to remember to execute each month. Most banks allow recurring savings transfers from internal or external checking accounts. Examine your budget and determine how much you can afford to save each pay period or month, and then make it happen, preferably on the same date (or the day after) you receive your paycheck or direct deposit.
8. Withdraw from Your IRA Without Penalty
Under certain conditions, your retirement account can serve as a supplemental funding source for your down payment.
This isn’t free money, of course. If you have a traditional IRA, you need to pay taxes on the withdrawn amount at your overall rate – 28% in the 28% bracket, and so on. On a Roth IRA held for longer than five years, your withdrawal is tax-free, because you’ve already paid taxes on the contribution.
If you and your spouse both have IRAs, you can both withdraw up to $10,000, for a total of $20,000. Depending on the projected size of your down payment, that could be a sizable boost. And, on Roth IRAs held longer than five years, you can withdraw tax- and penalty-free contributions in excess of $10,000, though any withdrawn earnings are taxable at your normal rate.
However, you also have to consider the opportunity cost of taking that money out of your account, potentially for years (by the time you make additional contributions to cover your withdrawal).
9. Take a 401k Loan
You can also borrow from employer-sponsored 401k or fund your down payment. On 401k loans, borrowing limits are much more generous: You can borrow up to the lesser of $50,000 or half the value of the account. That’s enough to fund a 20% down payment on a $250,000 house, or a 10% down payment on a $500,000 house.
However, the devil is in the details. You have to pay back your 401k loans, with interest – typically at 2% above the prime rate. On larger loans, that means several years’ worth of three-figure monthly payments and several thousand in interest charges. Plus, if you take out a 401k loan before applying for a mortgage loan, your credit utilization ratio will spike, which could raise your mortgage loan’s interest rate or cause the bank to think twice about lending to you in the first place.
As a general rule of thumb, 401k loans are useful in two situations: for funding small down payments ($5,000 or less) in their entirety or as the last piece of a multi-year, multi-source down payment funding strategy.
Your house might be the single biggest purchase you ever make, but it won’t be the only big-ticket item you ever buy. Unless you can comfortably live without a car, you’re likely to buy a used vehicle every few years. If you have kids, you’ll need to budget for their education. Once you’re ensconced in your home, you’ll probably want to make sensible improvements that enhance its value or accommodate your growing family. And, all the while, you need to have enough set aside for the unexpected.
Every one of these items, and many others not mentioned here, demand a measured, thought-out savings strategy. As you notch small victories in your quest to cobble together a down payment for your dream home, don’t neglect your other goals – whether you’re aiming to reach them next month, next year, or next decade.
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