Let’s discuss the steps you should take to successfully navigate the maze you’ll go through before the house warming party. This article will deal primarily with what most new home buyers consider to be the biggest stumbling block. The down payment.
Oh, so you didn’t realize that you’ve actually got to have some money to borrow some money? There are a few exceptions to that rule and we’ll talk about it later. Generally speaking, the best rates, points and availabilities are for mortgages (home loans) that are for 80% of the value of the property. So, 20% down is required. If you’re looking at a $250,000 home you’ll need $50,000 down.
Interest rates are still historically low, you have a good job, and you have a good credit score. Your first step should be to find a reputable, knowledgeable, realtor to help you walk through this huge financial effort. They have access to most all of the homes for sale in the area, mortgage bankers, brokers, property insurance connections, and closing companies to legally wrap the deal up.
However, it’s going to be up to you to come up with the money. I’ve bought several homes during my life and never once did the realtor offer to make my down payment. So, where do you go – how do you begin? Let’s take the obvious ones first and work down to the less obvious.
- Cash – if you fall in that category, you can stop reading and proceed to “GO” and get your deal done.
- Mom & Dad/Grandma & Grandpa Loan Company – If your parents/grandparents have the money to loan/give you that’s great! However, brainstorm this with your realtor, because there are some nuances that need to be brought to light. One of which is that even though it may be an interest free loan, your mortgage company will most likely impute interest, calculate payments, and add this to you DTI (debt to income ratio). Adding that monthly payment may decrease the size of the loan you’ll qualify for.
- CD’s (certificates of deposit) or life insurance cash values – Both of these offer loans on your principal at around 2% and offer very liberal pay back options. Check these out as an inexpensive option but be sure to fully understand the consequences if you die or default while the loan is in place. A good place to go to discover a wide range of down payment alternatives, government sponsored low/no down payment programs is – www.governmentauctions.org this covers; interest free loans, grants (you don’t have to pay these back), and other assistance plans for homebuyers.
- Military – The VA provides no down payment government insured loans for active and retired member of the armed forces. Use it! It’s one of a dwindling number of benefits we still have available.
- Low down – No PMI programs for professionals – Many states offer these advantages for professionals such as firemen, policemen, teachers, ect. The above mentioned website will help you find these.
- Your 401K – This is the most controversial of the options because it is like “borrowing from Peter to pay Paul” However, in this case, BOTH Peter and Paul should be making money for you. A home down payment is a legal way to borrow money from your retirement plan without having to pay penalties and taxes. Your 401K should be making money for you with the investment options you’ve chosen. The loan you take will also make money for you as you pay it back into you 401K with interest. So you’ve made a loan but you’re paying yourself back with interest. Your new home should appreciate in value each year so in essence you’re earning two returns on one loan – not a bad deal. This is not an early withdrawal, it’s a loan!
- Roth IRA and Traditional IRA – Remember when you opened your IRA? One of the advantages is you can take a qualified withdrawal from your account, without penalties, if you’re a first time homebuyer (no home ownership in the past 2 years).
All of these options will require some planning, explanation, and determination of what’s best for you. Contact you favorite Certified Financial Planner CFP® to help you understand these options and formulate the best direction for you to take financially. Other professionals to contact will be your CPA® to help you with the tax consequences for your home buying decision (most mortgage interest is tax deductible). If you chose to take a loan on your 401K, be sure to contact the actuary that provides the administrative over-sight for your company retirement plan.
Happy house hunting and welcome to the “American Dream”.
- Curtsey of Joe Psalmonds CFP®
President, JPJ Investments