Good NestingHowever, many families, including first timers, are having trouble putting money aside to get approved for a mortgage. Although not all mortgage programs require 20 percent down payment to proceed, rising home prices have made it difficult for families to gather enough money.
There are alternative ways to raise money to cover down payment. Crowdfunding, family gifts and retirement savings accounts are all valid sources of money. In this article, we explain how home buyers can take advantage of these methods to overcome the challenge of saving enough down payment for a mortgage.
Not all mortgage lenders require 20 percent down payment
Some first-time homebuyers think that they need no less than 20 percent down payment to purchase a house. However, although most lenders prefer receiving as much, there are lower down payment options that better suit the needs of families buying their first home.
The federal government operates several mortgage programs that require from 10 percent to no down payment at all. The best known mortgage programs are run by the Federal Housing Administration (FHA) and U.S. Departments of Veteran Affairs (VA) and Agriculture (DA). These loans are often approved with no down payment, although borrowers must agree to cover a funding fee. Mortgage insurance is also often a mandatory requirement for government-backed loans.
Some financial institutions also offer non-government backed home loans, also known as commercial mortgages, with low down payment, to first-time homebuyers. For example, Wells Fargo offer conventional fixed-rate mortgage loans with a down payment as low as 3 percent. Bank of America, in contrast, requires at least 5 percent down payment. In both cases, annual mortgage insurance will be required.
Finding ways to get approved for a mortgage loan with a down payment lower than 20 percent is only the first step. The money still has to be raised some way. Also, borrowers must be aware that lower down payment often means higher interest rates and monthly payments. As a result, a balance must be achieved in order to avoid a situation where monthly payments become a financial burden.
Use crowdfunding platforms to raise down payment
Crowdfunding is the process of funding a project by receiving small sums of money from a large number of people. This alternative financing strategy has existed for many decades, although it only gained in popularity as the Internet became more available. By 2011, crowdfunding platforms like IndieGoGo, Kickstarter and GoFundMe had gained widespread popularity. According to the Cambridge Center for Alternative Finance, more than $34 billion were raised through crowdfunding in 2015 alone.
Raising money for down payment is not allowed on most major crowdfunding platforms. In general, Kickstarter and IndieGoGo are meant to help small businesses receive funding to complete commercial projects such as toys, books, movies and video games. GoFundMe, on the other hand, is usually the place to get funding for life-threatening circumstances, such as expensive surgery or cancer treatment. However, GoFundMe does allow people to create campaigns to raise money for down payment.
In recent years, crowdfunding platforms focused on helping homebuyers raise down payment have appeared. One of the most popular options is HomeFundMe, created by mortgage banking firm CMG Financial. The website provides homebuyers assistance raising down payment for a mortgage loan. It also gives several unique benefits to users, such as being able to apply for mortgage prequalification once they register. Unlike other crowdfunding websites, HomeFundMe does not take a cut from contributions received through the platform.
HomeFundMe has some caveats. First, users must complete a homebuyer education course and can only use raised money to apply for a mortgage with CMG Financial. Also, they have up to twelve months to raise enough money to cover down payment and complete the mortgage application process. This means they are tied to whichever payment terms and interest rates CMG Financial offers, without the possibility to look for alternatives. However, the company usually matches contributions according to average median income, up to $2,500, helping families raise down payment even if contributions are scarce.
Those who want more freedom can choose FeatherTheNest.com. This crowdfunding platform can be used by first time homebuyers to build an online profile where people can submit contributions towards down payment. The website provides comprehensive assistance when managing a crowdfunding campaign, including social media.
To receive the money, users create a “nest,” which can be shared through social platforms like Facebook, Twitter and Instagram. The nest is linked to a bank account where contributions are stored during the campaign. FeatherTheNest.com does have transaction fees of 5 percent per contribution. Also, the credit card company in charge of handling the funding process charges an additional 3 percent. That means a family must raise $21,740 to complete a $20,000 down payment campaign.
Receive gifts or loans directly from family members or close friends willing to help
Receiving money from family members and close friends is another way of raising down payment. However, this method requires a significant amount of paperwork in order to satisfy mortgage lenders. This is because lenders want to make sure that a homebuyer is not borrowing money to cover down payment. If so, the risk of defaulting on their mortgage increases.
Lenders also require extensive paperwork because they must verify that benefactors have the financial capacity to make such donations. This often means family members will have to provide bank statements and other financial data that supports income. A letter confirming that the money is indeed a donation is also necessary.
If a family member provides the money as a loan, lenders will have to take it into account when analyzing borrowers’ applications. One key area affected by loaned down payment money is debt-to-income ratio, which represents how much income goes toward paying existing debt accounts. As the family loan was taken before the mortgage is approved, it is considered as existing debt, raising debt-to-income ratio.
In some cases, accepting money from family members with promise of paying it back might put borrowers above the maximum debt-to-income ratio accepted by lenders. In general, most mortgage lenders reject applications when borrowers have a debt-to-income ratio above 50 percent. However, exceptions can be made if some existing debt accounts are expected to be fully paid back in the near future.
Look for assistance from state and local sources
Another potential way of raising down payment money is by requesting help from local and state governments. According to Rob Crane, CEO of DownPaymentResource.com, there are more than 2,500 programs designed to help first-time homebuyers raise down payment money.
Down payment assistance programs are usually grants given by local governments to low income families. For example, the Texas Department of Housing and Community Affairs offers 30-year fixed-rate mortgage assistance and down payment coverage of up to 5 percent of the loan amount. The federal government also provides assistance through the HOME Investment Partnership Program, which gives low-income families funding to purchase or renovate a property.
Some non-profit organizations and local employers are also known to provide financial assistance to workers and volunteers. One of the most popular non-profits is Habitat for Humanity, which helps families build and renovate properties. Banks like Wells Fargo also run non-profit foundations that help low income families gain access to affordable housing.
The amount of money received through local and state programs can be significant. A 2016 study completed by Attom Data Solutions reported that, on average, families received up to $6,000 to cover down payment. The study also found out that families often received an additional $11,000 in monthly payment assistance.
Using retirement savings to fund down payment
Families who have retirement savings accounts may use a portion of that money to cover down payment. Although some might see it as risking their future, using 401(k) plans as a source for down payment has some benefits.
First, having a home which constantly rises in price may be better than keeping cash inside a retirement savings account. The interest rate offered by 401(k) and other IRAs can be lower than the average annual increase in home prices. Second, homes are an asset which can be used to borrow money later on if needed. Using a 401(k) does not mean the money goes away. Instead, it is transformed into equity.
However, borrowing or withdrawing money from a retirement savings account often has penalties. Contributors who are younger than 59½ years usually have to pay a penalty, and in the case of a 401(k), income taxes. 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 IRA, income taxes are not a concern as money stored in such accounts has already been taxed. However, IRAs allow only up to $10,000 to be withdrawn for home purchases.
Down payment is only one of the many items homebuyers have to worry about. Those who are buying a home for the first time should also seek to avoid common mistakes that might make the process more difficult. However, most families who complete a purchase have found their way out of financial hardship.
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