Tips on how to save up for a down payment

iStock_000009450603SmallGet Rich Slowly recently posted How to Save Up for a Down Payment Fast.  I’d like to respond to some of the ideas offered in GRS’s post from a Mortgage Professional’s viewpoint and offer my advice.

Here are some of the suggestions on How to Save Up for Down Payment Fast along with my 2 cents (in italics).

Get help from family. My dad pitched in $10,000 as an advance on my inheritance. When he passes away, I’ll get less money than my sisters, which he thought was the fair way to do it.

Mortgage lenders would most likely be treat this as a gift. Check with your lender to see what type of documentation will be required. It’s possible the parent would need to provide a gift letter which basically states no repayment is expected. Various mortgage programs may have requirements as to how much gift funds are allowed on a certain transaction depending on the type of mortgage.

Buy a fixer-upper that doesn’t need immediate fixing. We bought a house in less-than-pristine condition, which meant we paid less. We then gradually fixed it up, doing most of the work ourselves. Think of it as trading a larger down payment today for expenses that are spread out over the next year or few.

A home that needs just cosmetic fixing up probably will not be an issue to the lender. If you find a home that needs a little extra TLC or a lot of TLC, you may want to consider an FHA 203k mortgage. An FHA 203k mortgage will allow repairs to be financed into the mortgage with a very low down payment.

Sell your stuff. I have moved a few times in my life, and each time I made $1,000 or more from selling stuff on Craigslist, to colleagues, or at yard sales. Bonus: less stuff to move!

Great idea. Just make sure that you keep records of the transactions. Keep copies of your ads along with any receipts. You will need to show where the funds came from. “Cash” is never okay when it comes to funds for closing when buying a home. Large deposits that cannot be easily identified as payroll need to be documented.

Use IRAs. As an adviser for a retirement-planning service, it almost hurts me to type this. But if you are willing to retire later in exchange for a home today, you have options. Taxable distributions from an IRA might be exempt from the pre-59 ½ 10 percent penalty (but not taxes) if you are a “first-time home buyer,” which the IRS defines as someone who “had no present interest in a main home during the 2-year period ending on the date of acquisition of the home.” So you might still be eligible even if you have owned a home previously but not recently. The penalty-free distribution is limited to $10,000 per qualified person (including both spouses if both are “first-time buyers”). Also, contributions to a Roth IRA can be withdrawn any time tax- and penalty-free; however, this doesn’t apply to the growth or a Roth employer-sponsored account. But before you touch any of your IRAs, make sure you know the rules.

You may also be able to borrower against your 401k through the plan administrator and pay yourself back instead of doing a “withdrawal”. Check with your plan administrator to see what your options are. Borrowing against your retirement through your plan may help you avoid tax penalties on the withdrawal. 

Sell your body. Participation in medical tests can earn you money or free health care. I know it sounds weird, but it’s how I got my wisdom teeth pulled for free. Visit the website to search for clinical trials in your area.

I almost excluded this one from my post… except I have to add that if you do this, make sure you have documentation to show where the funds came from.

Get help from your boss. If you are a valued employee, you might be able to ask for a raise or an advance on your bonus or paycheck. You might also ask if you can take a benefit in the form of cash. This can be tricky for employers, since it can mess up their accounting. But it might be worth a shot if you have a good relationship with the purse-strings-that-be. Feel free to play the “we’re having a baby!” card if you work for a family-friendly company.

An advance would probably be viewed as a loan and may not be eligible for funds for closing. If it is an advance on a bonus, it *might* work…check with your lender.

Getting a raise is sweet. Be careful of changes to the structure of how you are paid. If you are paid salary, a raise is easy to factor in for qualifying. With hourly wages, it shouldn’t be difficult to figure out income either. However, if you’re adjusting your salary lower to have a larger commission structure or bonus, check with your mortgage professional first as it’s very probable that your income used for qualifying may be limited to the reduced salary – even if the end result is more income. 

Bonus income may be used for down payment, however, unless it is something that you can document receiving for the past two years from your employer, it may not be used for income qualifying purposes.

Get help from the government. Some state and local governments offer assistance to younger or lower- to middle-income citizens. Uncle Sam’s FHA also has programs for cash-poor home buyers. But if you are getting a loan that requires a down payment lower than 20 percent of the home’s value, factor in the possible higher long-term costs, such as a higher interest rate and private mortgage insurance.

FHA does not have income limits and does offer lower down payments and, believe it or not, conventional mortgages now offer slightly lower down payments than FHA. Borrowers who have served our country may qualify for a VA loan with no or greatly reduced down payment required. In addition, if you are willing to buy in a rural area, you can consider an USDA mortgage which does not have a down payment required as long as you meet income limits.

Down payment assistance and grant programs are also an option for home buyers with moderate or lower incomes. The income limit for the Home Advantage program is $97,000. Some down payment assistance programs have income limits that are lower than Home Advantage. 

In Get Rich Slowly’s blog post, there are some comments where they oppose buying a home with less than a “full” down payment. They argue that it would better for people to rent a larger apartment and save up for a down payment. While I do agree that there are times when renting does make sense, it really boils down to that individuals needs and goals. In the greater Seattle area, rents are on the rise and currently, one may be able to buy a home or condo with what they would be paying for in rent.  In addition, it could take quite some time for folks to save up for a larger down payment.  I would rather see someone put less money down towards a home instead of tapping all of their savings. Owning a home can be expensive and unlike renting, when something goes wrong, it’s probably going to be your expense.

One tip I offer in the home buyer classes that I teach is to start practicing making your mortgage payment. If you have an idea of what you want to spend for your monthly mortgage payment, and it’s more than what you’re currently paying in rent, pay the difference to your savings account and “practice” making that mortgage payment. You’ll see if you’re comfortable skipping your lattes making that bigger payment and meanwhile, build up your savings.

You may also want to delay paying off debts. Paying off debts eliminates funds that could go towards your funds for closing and it may also hurt your credit scores. Lenders will use the minimum payment due as reflected on your credit report for revolving debts when factoring your debt-to-income ratios for qualifying. So even though you have a credit balance looming and paying off that credit card feels like the right thing to do, it may actually hurt you when it comes to qualifying for a mortgage. In some cases, lenders like to see at least 3 active tradelines on borrowers credit report. Also, some installment debts with a shorter term (10 months or less) remaining on the loan, may be able to exclude the debt payment from the ratios.  You can always pay off debts after you close on your new home.

Bottom line, if you are considering buying a home, you cannot start the process too early with your lender. I encourage you to meet with a local licensed loan officer to create a game plan – even if you’re not planning on buying for a year or more.

PS: If you are thinking about buying a home located anywhere in Washington state, please contact me. I am happy to help you through the mortgage process as your Licensed Loan Officer.

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