How To Raise Down Payment To Purchase A Home

To combat a slump in home sales, the industry came up with several programs to keep people buying homes.

In this article, we explain the four most effective ways homebuyers are using to fund down payment. Among them are collecting small donations from many individuals through crowdfunding platforms, using gifted money from friends, and a number of widely available government programs.

Do you need 20 percent?

The first thing first timers learn when searching for a mortgage is that they need 20 percent of the home’s value as down payment in order to get approved. However, this is not always the case. Although most private lenders prefer customers who can provide as much, there are some mortgage programs that people can qualify for with low or no down payment.

The federal government operates three popular mortgage programs low income families can use to purchase their first property. One of them is called FHA mortgage loans, and require between 3.5 and 10 percent down payment. The other two are VA mortgages and USDA loans. VA mortgages are administered by the U.S. Department of Veteran Affairs (VA) and is available to servicemen, veterans or their surviving spouses. USDA loans are administered by the U.S. Department of Agriculture (DA) and are available to rural and suburban families. Both VA and USDA loans can be obtained without providing a down payment. However, in some cases, borrowers must agree to pay mortgage insurance.

There are financial institutions that offer mortgage loans with a down payment. Usually, these loans are only available to first-time homebuyers as a way to incentivize homeownership. Wells Fargo, for example, offers a mortgage loan that requires only three percent down payment. Bank Of America has a similar offering, though borrowers must provide five percent instead. In either case, homeowners must agree to pay private mortgage insurance to offset the additional risk.

Despite that, potential homebuyers must be aware that finding a low down payment mortgage program is but the first step. The next logical step would be to raise money. Also, they must understand that, by providing a lower down payment, they agree to higher interest rates and monthly payments. As a result, it is important to try and achieve a balance that does not put down payment above what they can afford, while at the same time making sure monthly payments do not become a burden.

How to crowdfund your down payment

Crowdfunding is a process were people and institutions can fund a project by receiving small donations from many donors. This financing approach has existed for many years. However, it gained significant popularity in the last few years as the Internet became more available. Crowdfunding platforms like IndieGoGo, Kickstarter and GoFundMe are among the most popular to fund any kind of project. In fact, research from the Cambridge Center for Alternative Finance revealed that more than $34 billion are raised every year through such platforms.

When it comes to raising money for a down payment, homeowners will face some issues. First, doing so is not allowed on most major crowdfunding platforms. Kickstarter and IndieGoGo, for example, are meant to help individuals and small businesses obtain money to complete projects that create products that can be sold or given away, such as toys, books, movies and video games. GoFundMe, on the other hand, is often the place where people find money to cover an expensive surgery or fund cancer treatment. GoFundMe does allow people to create campaigns to raise money for a down payment, albeit only in certain circumstances such as when people cannot work.

Although the major crowdfunding platforms do not support raising money for a down payment, new alternatives have appeared. Among the most popular options is HomeFundMe, which was created by mortgage banking firm CMG Financial. Through this platform, homebuyers can raise down payment for a mortgage loan. They can also apply for a pre-approval letter once they register. Most traditional crowdfunding platforms charge users a fee that often represents a small percentage of all money raised. HomeFundMe does not. Instead, the website imposes some limits on how money raised can be used and asks beneficiaries to complete some additional steps.

First, potential homebuyers must participate in an education course. Second, they can only use the money they raised as a down payment for a mortgage loan with CMG Financial. This means that homebuyers are tied to the payment terms and interest rates offered by CMG Financial, without any alternatives. Also, the platform gives participants up to twelve months to raise enough money to cover down payment and complete the mortgage application process. Although this may look discouraging, the company does give beneficiaries up to $2,500 in the form of matching contributions.

Homebuyers who want more freedom can try FeatherTheNest. This platform does not operate like other crowdfunding websites. Instead, it helps first timers build an online profile and receive money from family and friends through social media. To receive the money, homebuyers create a “nest”, which works like a project from other crowdfunding platforms. However, nests are directly connected to a bank account where the money is deposited as it is being donated. After they create it, homebuyers can share their nest through social media platforms like Facebook and Twitter.

Unlike HomeFundMe, FeatherTheNest does take a cut from contributions. This transaction fee equals five percent of each contribution. The credit company also charges a handling fee that equals an additional three percent. This means that for each $1,000 raised, $80 will be taken away to cover those fees.

Your family can gift you money

Another way of raising down payment is to receive money from family members and close friends. However, this method requires a significant amount of paperwork in order to meet lender requirements. In general, lenders make sure that homebuyers are not using borrowed money to cover down payment. If so, they will consider it a family loan and count it towards debt-to-income ratio, which may lead to a denied application.

Debt-to-income ratio represents the percentage of monthly income that goes toward paying existing debt accounts. As the family loan was taken before the mortgage is approved, it is considered as an existing debt, raising debt-to-income ratio.

Lenders also do this because they are required to verify that the friends and family members that sent the money actually have the financial capacity to make such donations. To verify this, lenders often ask for bank statements and other financial data that supports income. A letter that confirms the money is indeed a donation is also required.

Receive funding from the government

Requesting help from state and local government agencies is another potential source of money. Rob Crane, CEO of DownPaymentResource, reports that more than 2,500 down payment assistance programs exist nationwide. These programs target first timers who are not financially capable of raising the funds themselves.

Down payment assistance given by local and state government agencies are usually considered as grants. This means they must not be paid back as long as the money is used as instructed. In Texas, for example, the local Department of Housing and Community Affairs offers first time homebuyers down payment assistance to apply for a 30-year fixed-rate mortgage program. The agency often provides as much as five percent of the home’s value, with some restrictions. The federal government also runs several down payment assistance programs that can be used along with those offered by local entities. One of the most popular programs is the HOME Investment Partnership Program, which provides money to purchase and renovate properties in key areas around the country.

Non-profit organizations and local companies also provide down payment assistance to potential homeowners. Habitat For Humanity remains one of the most popular options for low income families. This organization helps families renovate homes. In some areas, they also help build new ones as long as homebuyers participate in the construction process. Some banks like Wells Fargo operate non-profit institutions and foundations that donate money to low income families.

The amount of money received through local and state programs can be significant. A 2016 study completed by Attom Data Solutions revealed that, on average, families received up to $6,000 that year to cover down payment. The study also found out that some families received an additional $11,000 in total monthly payment assistance.

Using retirement savings to fund down payment

Although retirement savings accounts are not meant to serve as a source of money for a down payment, families who have no other option can rely on these accounts to cover down payment. It might risk their future, although the money can be later recovered through a home equity loan or line of credit. Also, using a 401(k) or similar account to fund down payment does have some unique benefits.

First, rising home prices mean that purchasing a house may be better than storing the money in a retirement savings account. Interest rates offered by 401(k) and other retirement accounts are often lower than the average annual increase in home prices. Second, and as mentioned above, homes are a valuable asset that can be used to borrow money if needed. Using a 401(k) does not mean the money is no longer available in case of an emergency. Instead, it is transformed into equity.

However, homebuyers who borrow or withdraw money from their retirement savings account may face some expensive penalties. Contributors who are younger than 59½ years usually have to pay both penalties and income taxes when taking money away from their retirement accounts. This means that to cover a $10,000 down payment, some people may have to withdraw as much as $13,000. Also, if someone withdraws money and then loses their job, some special conditions such as immediate repayment may become a problem.

If money is withdrawn from a Roth retirement savings account, income taxes are not a concern as money stored in such accounts is tax free. However, only up to $10,000 can be withdrawn from such accounts for the purpose of funding a home purchase.