Most Americans want to own a home, but the hefty down payment required to purchase a house makes buying property a difficult hurdle for many to overcome.
Banks and other lenders often seek a down payment of 20% of the purchase price for the home. If you pay anything less, you'll need to buy private mortgage insurance (PMI). PMI is insurance that protects the lender if a borrower defaults, which is when a borrower can't make any more payments. The PMI goes away once the mortgage is under 80% of the purchase price of the home.
For those looking to buy a home, PMI insurance adds to the monthly outlay of cash for payments. PMI payments are non-recoverable expenses that do not pay down the principal balance of your mortgage. On the other hand, coming up with 20% of a home's purchase price may take years to save up for, especially in hotter real estate markets.
Potential homeowners have plenty of options for obtaining these savings goals. In this article, we review some of the most common methods used to come up with the cash needed for a home down payment.
Key Takeaways
- Most Americans want to own a home, but the required down payment can make owning a home difficult to obtain.
- Potential homeowners can come up with the down payment by getting a part-time job or borrowing from family.
- Family members can also contribute gifts of lump sums of cash, though there are tax considerations worth noting for gifts.
- Downsizing to a smaller apartment—saving rent—can save thousands of dollars per year.
- Programs can help, such as the Federal Housing Administration (FHA), which offers mortgage loans through FHA-approved banks.
Look for Down Payment Assistance Programs
Most people who don't have enough for the down payment accept private mortgage insurance as a necessary evil without first checking if they're eligible for assistance. For example, many banks have their own programs to help those looking to buy a home. It pays to check the local banks in your neighborhood.
The Federal Housing Administration (FHA) offers loans for low-to-moderate-income borrowers through FHA-approved banks or lenders. The mortgages are backed by the U.S. government, meaning the lender doesn't have any risk. As a result, borrowers have more favorable treatment with FHA loans versus traditional mortgages. For example, you may only need to come up with a 3.5% downpayment versus the 20% that banks typically like to see.
If your credit history isn't perfect, FHA loans may also help since borrowers with a credit score of above 580 can qualify for the program. A credit score is merely a numerical representation of a person's credit history that includes factors such as late payments and the number of credit accounts.
Veterans and active-duty military can also get help by qualifying for VA loans provided by the U.S. Department of Veterans Affairs. VA loans or mortgages require zero down and typically offer a favorable interest rate. States also give consumers down payment assistance through a variety of programs.
The United States Department of Agriculture Rural Development offers single and multi-family home loans with zero down payments. There are also programs geared toward encouraging people to purchase homes in a particular neighborhood or region.
Tap Into Benefits for First-Time Buyers
Coming up with a down payment is particularly challenging for people who have never owned a home before, but many incentives exist for first-time buyers. Furthermore, more people qualify for these benefits than you might think. If you haven't owned a home in three years or only owned a house with a spouse, then you can access incentives for new homebuyers. You may also be able to get these benefits if your only home is a manufactured home that is permanently affixed to a permanent foundation.
The Department of Housing and Urban Development (HUD) supports programs for first-time buyers, and some states have first-time homebuyers savings programs. With the accumulated interest, the savingsaccounts could potentially help some buyers save for the down payment on their homes at a faster rate than they would have been able towithout the account.
First-time homebuyers can also take up to $10,000 from a traditional IRA or Roth IRA without the 10% early withdrawal penalty. What is more, there are programs to help Native American first-time homebuyers. Do not assume you cannot afford a down payment just because nobody in your family ever owned a home. Also, be aware that demanding an overly high down payment can be a sneaky way to discriminate against minorities.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).
Supplement Your Income With a Part-Time Job
Unfortunately, one of the consequences of the 2008 financial crisis and the ensuing Great Recession is that banks no longer offer no-income verification loans, zero document loans, or mortgages for 100% of the home's value.
These days banks and lenders require income verification and a debt-to-income ratio of no more than about 43%. The debt-to-income ratio is a metric that measures how much of your monthly gross income goes to debt payments. For example, if you have $5,000 in gross income and make debt payments totaling $1,500 per month, your DTI is 30% or (($1,500 / $5,000) x 100 to create a percentage). Debt payments can be from a mortgage, student loans, and credit cards.
Some lenders will accept a lower down payment, but borrowers might pay for it in the form of a higher interest rate. Borrowers that put less than 20% down for the mortgage will pay PMI, which can cost nearly $100 per month on top of the mortgage payment.
As a result of the more stringent income requirements, would-be borrowers may need to get a part-time job to supplement their income. The extra money should be placed in a savings vehicle to be used only for the down payment.
Sell Some of Your Belongings
People ready to take the step into homeownership typically have a lot of stuff they've acquired along the way. Those things may seem worthless to the owner, but that old car or piece of furniture might be what someone else is interested in buying. Selling used goods can help supplement your income and raise much-needed cash for the down payment. The Internet makes it easy to sell everything from clothes to electronics. Some of the sites let you do it for free while others take a cut of your profit.
Downsize Your Lifestyle
If you want to free up cash to save for a home, downsizing your lifestyle could go a long way in saving money. For example, you could move into a smaller apartment or studio apartment to save on rent and utilities. If your two-bedroom apartment has a rent of $1,200 per month, switching to a $600-per-month studio will save you over $7,000 annually. If you're a couple with two cars, perhaps selling one of them to cut down on car loans can help cut expenses. Even cutting back on dining out or buying a coffee can add up and steadily increase the amount you save.
Lenders will want to see a gift letter that confirms a lump sum provided by a family member is gift, not a loan that is to be repaid in the future. This legal document must be signed by the donor.
Ask for a Gift From Family
Asking family or friends for money may not seem like the ideal option. However, if you have a favorite aunt, grandparent, or cousin that has a lot of cash, it could be a win-win for both of you. If you're gifted some or all of your down payment, it will not only be a good deed, but they can get a tax write-off from it.
The Internal Revenue Service (IRS) allows people to give gifts worth thousands of dollars per year tax-free for the donor and the recipient. The gift tax exemption depends on the amount gifted. In 2022, the annual exclusion for gifts was $16,000, and the exclusion will increase to $17,000 in 2023.
Please check the IRS site for any changes in tax laws before accepting cash gifts. If a gift is out of the question, ask to borrow the money, and come up with a repayment schedule that also includes interest.
Do I Have to Put 20% Down for a House?
There are many programs and lenders that accept less than a 20% down payment during the purchase of a house. However, there are several downsides. First, lenders will usually require borrowers to pay for insurance (PMI) until they reach the 20% equity level. Second, lower down payments result in higher loan amounts, increasing the required monthly payment sought after by the bank.
What Is the Minimum Amount for a Down Payment?
Federal Housing Administration (FHA) mortgages require down payments of only 3.5% of the home's price. In addition, VA and USDA loans are two other government-sponsored loans that may be secured with no money down.
What Is the Rule of 36?
The rule of 36 is guidance on how much your monthly mortgage payment should be. The rule states that no more than 36% of your gross income should be attributable to debt, and this includes your monthly mortgage. For example, if your gross income is $10,000 per month, your total monthly debt including home payments, car payments, credit card debt, student loans, and other debt should total no more than $3,600 per month.
How Many Times Salary Should My Mortgage Be?
Lenders often allow borrowers to incur debt roughly 4 to 4.5 times their annual pay. For example, if your annual salary is $100,000, it's most often advised you pursue a mortgage no more than $400,000 to $450,000.
The Bottom Line
Homeownership is the dream for many, but the down payment may prevent some from realizing that dream. While coming up with thousands of dollars may seem impossible at first, there are many non-traditional ways to raise cash for your down payment.
