Over the last several years the approval process for loans has tightened up along with higher credit score and down payment requirements. Fortunately, this past year has seen some loosening of loan requirements, enabling more buyers to gain approval. This is stimulating the housing market.
Instead of requiring 20% down, loans are once again available with smaller down payments. FHA loans can be obtained with 3.5% down and some conventional loans are offering a 5% down payment option. This has spurred new bank programs requiring down payments of under 5%.
There are only two loan options that offer zero percent down and those are VA loans for veterans and some special programs for physician’s loans. Even with a zero down option a buyer may still be responsible for 2% to 3% in closing costs, which can add up to thousands of dollars.
How Much Down Payment Do You Need?
Down payments are a percentage of the cost of the home, therefore it will vary based on the sales price. For easier calculations consider that 1% of a $100,000 loan is $1000. This means a $500,000 loan with 5% down will require $25,000 plus another 10,000 to $15,000 in closing costs.
Where Can the Down Payment Come From?
Borrow from your 401K. If you and/or your spouse have a 401K with your current employer it is possible to borrow up to 50% of the vested balance for a down payment on a home purchase. While this is a loan that must be paid back, essentially you are paying yourself and the interest is added to account balances. The key disadvantage to a 401K loan is that if you change jobs you must pay back the 401K loan or it will be considered a distribution that will be both taxed and penalized if you are under 59 1/2.
If you are buying a home and starting a new job, this may not be a viable option because the 401K must be held at your current employer. It is sometimes possible to transfer 401K balances from a previous employer to the new employer, enabling you to take advantage of this option.
IRS Distribution. The IRS rules allows you to withdraw up to $10,000 to purchase a new home. This option is available to first time home buyers who have not owned a home in the last 2 years and can only be used once. If the funds are withdrawn from a ROTH IRA then there will not be tax consequences. If you are withdrawing funds from a Traditional IRA then the 10% early withdrawal penalty is waived as long as the requirements are met. You will, however, still be responsible for taxes at your ordinary income rate.
Gift from Parent, Grandparents or other direct relative. This is a common way to obtain a down payments if your parents or other relative are in a position to help. The gift laws allow for up to $14,000 to be gifted per person per year. This means your mother and father can gift you $14,000 each providing a tax free gift of $28,000 in a single year. If you have a spouse that number could rise to $56,000. Note that lenders generally require a letter with the gift stating it is a gift and does not have to be repaid. Some lenders want to see the money in an account for 60 days prior to closing. It is important to review the requirements with your lender.
Borrowing funds from others. If your parents or relatives cannot gift funds perhaps they are able to lend you the money for a down payment. When this occurs the loan payments that must be repaid will be considered in the debt to income used by the lender. This might reduce the amount of the loan approval but can provide a way to get into a home without having saved to full down payment amount.
Many states offer down payment assistance programs, however, these are generally reserved for low to moderate income earners and physicians typically will not qualify. Another option would be to seek grants that can be used to purchase homes. In this case the neighborhood or type of home will likely dictate the ability to be approved for the grant.
Physicians have the benefit of loans that are specifically geared towards your needs. This includes lower down payment requirements and sometimes no down payment options. Closing costs will generally still be required and can add up to a significant amount. If you are choosing a zero down payment physicians loan, consider asking the seller to assist with the closing costs, keeping the amount needed at closing to a minimum.