A 20% down payment is preferred by most mortgage lenders, but not everyone has that much cash available to them and you can get away with much less. Federal Housing Administration (FHA) loans require only 3.5% down. You can come up with that much or more if you take the right steps to tap your own income or find other sources of money.
- When buying a home, it's ideal to make a 20% down payment so you can avoid having to purchase private mortgage insurance (PMI).
- To come up with 20%, you can save your tax refund, set aside some savings, borrow from your parents, or ask the seller to help out.
- You can also look into government programs, consider 100% financing, or tap into your retirement funds.
The 20% Goal
It's worth it to strive to come up with as much of a down payment as possible—ideally 20%. Conventional lenders want some assurance that you, too, have a significant stake in the property and that you'll fight tooth and nail to prevent it from going into foreclosure. The more of an investment you have in it, the better.
If you don't make a 20% down payment, you'll need private mortgage insurance (PMI). The extra cost of PMI is typically built into your mortgage payment. Use our mortgage calculator to estimate how much PMI will increase your payment.
There's a lot to be said for raising cash for a healthy down payment, and you have options.
Save Your Tax Refund
You can increase your federal income tax withholding if you lack the discipline to save something of each paycheck. It's simply a matter of submitting a new W-4 to your employer, asking the company to withhold more. Your employer will pay more of your paycheck to the Internal Revenue Service, and this is likely to result in a larger income tax refund for you.
Even a regular tax income refund might be enough to help you buy a home.
Of course, the downside to this is the IRS doesn't pay interest. It just holds onto your tax money all year, then it gives it back to you dollar for dollar if you don't end up owing as much as you had withheld. A savings account paying even minimal interest can be a better option if you're disciplined enough to save something every pay period.
Set Aside Savings Periodically
The secret to making a savings account grow is to make identical deposits at the same time every month. You can arrange for a certain amount of your paycheck to be direct-deposited into your savings account, or you can transfer a set amount from your checking account to your savings account every pay period.
You'll have saved $5,200, plus interest earned, at the end of 12 months if you're paid every two weeks and save $200 from every paycheck.
Borrow From Your Parents
It's not unusual to ask your parents for money to help you buy a home. Federal tax law lets each parent give you a certain amount as a gift without tax consequences—$15,000 per person per year as of 2020. Your parents could give you twice that, or $60,000, if you're married—$30,000 to you ($15,000 from each parent) and $30,000 to your spouse—without incurring a gift tax bill.
This gift tax exemption increases periodically to keep up with inflation.
You'll have to be able to prove that the money is indeed a gift, however, and that you're not expected to repay it at any point in time, particularly if you're hoping to qualify for an FHA loan. HUD has strict rules for exactly who can and cannot gift you money. Relatives and friends are acceptable sources—as long as they don't expect repayment.
Ask the Seller for the Money
You'd be surprised at what some sellers will do if you're willing to pay their asking price. Some will give you the down payment as a credit, pay your closing costs, or both. You won't know unless you ask. That's more money you can dedicate to your down payment if the seller agrees to give you a credit for closing costs, freeing up those funds for use elsewhere.
Check with your lender before asking for assistance from the seller because some have strict requirements as to how much of a credit you can receive.
Look into Government Programs
You might qualify for a VA loan backed by the U.S. Department of Veterans Affairs if you've served your country in the Armed Forces.
The government also runs several down payment assistance programs for first-time home buyers. HUD won't give grants and assistance to individuals, but it does fund local governments and some non-profit organizations.
You might also check with your county to see if it offers special programs to encourage homeownership in certain neighborhoods or for other reasons.
For example, New Jersey has a program that offers $10,000 to qualified homebuyers who purchase within the state. It's a no-interest, forgivable second loan with no monthly payment and the balance doesn't come due for five years.
Consider 100% Financing
You might qualify for a 100% loan if you have excellent credit and your community offers special first-time home buyer programs. This could be a single mortgage backed by mortgage insurance, or you might qualify for a "silent" second mortgage that comes due when you sell.
Talk to your mortgage broker to see which programs might be available for you.
Tap Your Retirement Funds
Certain retirement accounts will let you borrow from them to buy a home. Check with your accountant for current regulations. Some will let you take out the principal balance without a penalty.
You can't tap into an IRA, but you can usually borrow from your 401(k) subject to certain rules. Individual plans can limit the amount you can borrow, and the money will become taxable if you default on the loan.