Finding Money for a Down Payment on a House
Posted by miller on 14 Feb 2008 at 01:23 am | Tagged as: Housing/Mortgages
Being a prospective home buyer, one of the first questions that crossed my mind was how to come up with a down payment. In the post housing bubble age of the Credit Crunch, it is extremely hard to get full financing or other exotic loans. Down payments are, once again, important. The old convention says you need 20% down. Well, how in the world I am going to find 20%? Remember, houses have become harder to buy historically — especially for the younger crowd. Here are some ideas…
The down payment question is a big barrier for younger buyers. Plenty of young adults make enough money to comfortably pay a mortgage, but simply don’t have the thousands saved up for the down payment. The amounts necessary can seem too daunting, so people give up on saving before they even start. Say you need $50k. Even saving $250 a month, this would take over 16 years!
This brings up the all important question of how much you really do need for a down payment. Convention says 20%. During the housing boom, sometimes you didn’t even have to cover closing! And now, during the Credit Crunch? Going through the process right now myself, I am happy to report that with good credit, you still don’t need the 20%. From the mortgage brokers I’ve spoken to, 5% seems to be the minimum. 10% is the strongly desired. 20% seemed only necessary to avoid mortgage insurance and/or piggyback loans. However (and this is where the Credit Crunch gets you), the trick is that you really need good credit. Supposedly, while the Credit Crunch hasn’t affected those with good credit, it really has put the brakes on those with less than perfect credit.
So assuming you have less than perfect credit or that you don’t even have the 5% saved up, what are your options?
- Save: Sorry, I know this is terribly obvious, but it is also terribly important. While it might take a while, start saving a few hundred away each month if you can. Depending on your time line, you may even be able to invest this in stocks. Set your online bank to take an extra bite of your pay check every month. This is actually also a really good way to “test drive” a mortgage. Assuming a mortgage would be more than your rent, force yourself to save the difference between the two. This will give you a sense of what living with that mortgage would be like.
- Pull Out Some from Your Roth IRA: One of the little appreciated facts of Roth IRAs is that you can pull contributions out at anytime with no penalty! So if you have thousands saved there, you might be able to tap that resource. However, funding your down payment with your retirement comes at a huge cost. You can never make up those years’ worth of contributions. Ideally, you would never tap into your retirement early, but your finances are a balancing act. If you find yourself “heavy” on retirement and “light” on a down payment, the option is there. Another strategy I actually used for about 6 months was to increase my 401K contribution and use your Roth IRA as a down payment savings vehicle. This assumes you aren’t already maxing out your retirement (I’m not so lucky). The advantage is that your down payment money (in your Roth) grows tax free. The tax free compounding can help a lot long term. Then, you pull out your contributions when you need it. All things being said and done, I will not be pulling out of my Roth IRA for my down payment mostly because the market has tanked in the last six months.
- 401K Loan: This option is fairly similar to pulling money out of your Roth IRA, with a few twists. For one, to avoid penalties the money would come in the form of a loan. You have to pay it back. And, you have to pay interest! Luckily, the interest is credited to your own account. Unfortunately, you will be doubled dipped on taxes in the exchange. You will pay taxes on the loan when you take it, and you also have to pay the loan back with post-tax dollars. This is the killer that makes this option less desirable.
- Gift: Last but not least, you can always beg Mom and Dad for help! This is becoming more and more common these days as it is becoming harder for young home buyers to come up with their down payments. If you are lucky enough to be in this situation, first and foremost thank your parents for the generous gift! Second, understand the gift tax laws. $12k per calender year may be given tax free as a gift. If a parent wanted to gift you more, I would suggest splitting the gift up between calender years to avoid taxes. After all, your parents want to give you the money, not Uncle Sam!
Getting a down payment together is hard! Inflated housing prices across our country doesn’t help either! The good news is, with good credit, you don’t need 20% down. The bad news is even 5% plus closing costs is easily tens of thousands of dollars! So ultimately, how have I come up with my down payment? Honestly — good ol’ savings. I kept my head down for a few years and the money slowly grew. I also happened to hit good timing in the market (pulled out at end of last Summer!), which helped. I had originally planned on using some Roth IRA funds (while up’ing my 401K to reach my monthly retirement goal), but with the down turn of the market, selling is the last thing I want to do with my IRA! So, in the end, it came down to savings. Sort of anti-climatic, no?
I’m in these shoes, too. My wife and I are (trying) to do it all right, but amassing the money for a down payment just seems impossible.
How am I supposed to save up 20% for anything livable in my area ($400k or so)? We have the emergency fund, do the 10% in the 401k, automatic deposits into two Roth IRAs, and then we still have to put away money for a house.
Jason — I feel your pain! While it gets sticky very quickly, another option is to put down your 401k contribution to build that down payment (though, always get your company match!). I actually did this. This is sticky because you are sacrificing retirement. *But* at some point, there exists a trade off between retirement and buying a house. The (ridiculous) extreme would be if you could never ever afford a down payment because you were always saving for retirement! Well, your retirement would cost you a LOT LESS if you owned a home and didn’t pay rent, right?? So, again, somewhere there is that trade off (though its obviously a very situation dependent question).