Home down payments: Do's and don'ts

By Amy Fontinelle
Amy Fontinelle is a personal finance writer focusing on budgeting, credit cards, mortgages, real estate, investing, and other topics.
Posted on Apr 18, 2018

Is not having a down payment stopping you from buying a home? For more than two-thirds of the renters Zillow surveyed in April 2017, it is.Even when renters could easily afford a monthly mortgage payment thanks to low interest rates, they have to keep renting if they don’t have a pile of cash to put down to buy a house.

Not everyone wants to be a homeowner. It requires a commitment of time and resources that renting doesn’t. But if you do want to become one, here’s some advice on what to do — and what not to do — to put together a down payment.

Do: Consider a down-payment assistance program

National, state, and local programs can help provide a down payment for homebuyers who meet credit, debt, and income qualifications. In California, for example, the Golden State Finance Authority provides gifts of up to 5 percent of the loan amount to low- and moderate-income homebuyers. An organization called Down Payment Resource tracks about 2,400 homeownership programs and can help match you online with those you qualify for. Another resource is your state housing agency, which you can find at the National Council of State Housing Agencies website.

Don’t: Assume you need 20 percent down

The traditional down payment has long been 20 percent. But tradition is changing, and you often don’t need to the full 20 percent down to buy a home these days.

If you’re a qualifying veteran, surviving spouse, or active-duty service member, you may qualify for a Veterans Administration mortgage, which requires nothing down. It does have an up-front funding fee, but you can tack it on to your mortgage. However, there have been reports that sellers are sometimes reluctant to work with buyers using such programs, because of the added time and paperwork required.

For civilians, the least you can put down is 3 percent. There are assistance programs by two major mortgage lenders. Freddie Mac’s Home Possible Advantage program helps those who earn no more than the local median income. And Fannie Mae has a 3 percent down program for first-time homebuyers. Lenders are willing to offer such low-down-payment mortgages because of private mortgage insurance, or PMI.

Do: Consider PMI or a piggyback mortgage

PMI costs a percentage of your loan balance each month. It protects the lender in case you default. Your PMI payment will be included with your mortgage payment each month. When you have 20 percent equity in your home, either through paying down principal or accumulating equity, you can ask your lender to cancel it, as long as you’re one to two years into your mortgage.

“PMI rates have come down dramatically over the years,” said Jeremy David Schachter, mortgage advisor with Pinnacle Capital Mortgage in Phoenix. The cost is credit driven, so the better your credit score, the lower the cost for mortgage insurance.

For example, on a 30-year, fixed-rate, $200,000 mortgage where you put down 3 percent of the home’s purchase price, if you have an excellent credit score of 760 or higher, you’ll likely pay about 0.45 percent of the loan balance per year, or $900, according to estimates. That’s $75 per month. With a credit score in the low 700s, you’d pay double that amount. (Learn more: Buying your first home)

It is also possible to put down less than 20 percent and avoid paying PMI in exchange for a slightly higher interest rate over the life of the loan, which could be more expensive than PMI in the long run because you can cancel PMI but you can’t cancel a higher interest rate. Here, the lender is paying PMI for you and increasing your interest rate to compensate.

Another option is a piggyback mortgage (sometimes called a second mortgage, but not to be confused with a home equity loan, which is also sometimes called a second mortgage). This is a small mortgage, perhaps provided by an affordable housing program, that can be used with as little as 5 percent down. The interest rate may be slightly higher than the main mortgage’s interest rate.

Don’t: Ignore the extra costs of a low down payment

Making a small down payment will result in a higher monthly mortgage payment. On a $200,000 home with a 30-year fixed-rate mortgage at 4.5 percent, the difference in the monthly payment when you put down 5 percent compared with 20 percent is about $150, by most estimates. PMI will increase that $150 difference further — it might cost around $75 per month, as shown above, which means your monthly payment will be $225 higher compared to putting down 20 percent.

But you’ll only have to come up with $10,000 instead of $40,000 to become a homeowner. And paying PMI in the short run may benefit you in the long run by allowing you to buy when mortgage rates and home prices are lower than they might be in the future. But borrowing more means paying more interest over time, so you have to weigh the costs and benefits and determine what you’re comfortable with. Borrowing an extra $30,000 for 30 years at 4.5 percent will cost you close to $25,000 in interest.

In addition to a down payment of any size, you’ll have to pay closing costs, which typically total from 2 percent to 5 percent of the home’s purchase price. You can pay closing costs with cash, roll them into your mortgage, or ask the seller to pay them. Closing costs include items such as the mortgage origination fee, title search and insurance, and escrow fees.

Do: Keep sufficient cash reserves in the bank.

Lenders usually require homebuyers to demonstrate through bank statements that they will have two months’ worth of principal, interest, property taxes, and homeowners insurance payments in the bank after closing. This money can help you stay current on your mortgage if your income drops. The amount the lender requires is a bare minimum; you’d be better off with a larger cushion. Homeownership comes with unexpected costs that you’ll want to be able to cover.

“It is very important that you don’t leave yourself cash poor when buying a home,” said Ralph DiBugnara, president of Home Qualified and vice president of Retail Sales at Residential Home Funding in Parsippany, New Jersey. “You will need money to furnish and personalize the home as well as to avoid the stress of payment shock from your new financing.” (Learn more: Setting financial goals: Savings)

Further, depending on the home’s age, appliances such as your hot-water heater, washer and dryer, and refrigerator may require maintenance and/or replacement soon after purchase, DiBugnara explained. On the exterior, you will have updating and maintenance on landscaping , chipping or peeling paint, and gutters. Newly built homes often come with just the bare necessities, and you may need to purchase lighting, fixtures, paint, and shrubs.

Don’t spend all your cash on your down payment, and continually rebuild your reserves any time you spend them down. There will always be something you want to maintain, repair, or upgrade on your home.

Don’t: Get a personal loan or credit card cash advance

Out of desperation, you might be tempted to take out a personal loan or even a credit card cash advance — which Schachter said he has actually seen clients do — to fund your down payment.

Most professionals will tell you: Don’t do it. While personal loans often have reasonable, single-digit interest rates if you have very good credit, credit card cash advances are typically very expensive. What’s more, lenders won’t count this money toward qualifying you for a loan no matter what interest rate you’re paying.

Besides, “It’s never a good idea to take on debt to take on more debt,” DiBugnara said. (Learn more: Credit card debt: The problem, fixes, and prevention)

Do: Request a gift or loan from a relative

Not every homebuyer has relatives who are financially able to gift or loan them several thousand dollars for a down payment. But if someone in your family does — a parent or grandparent, perhaps — why not ask?

“Borrowing from family is a great way to get a down payment,” said Stan Jones, a real estate agent with Atlanta Homes Today in Duluth, Georgia. “As an agent and a parent, I can think of no greater financial gift that could impact a family member than helping them buy a home.”

Loan qualification will be easier if you receive the gift more than 90 days before you apply for a mortgage so the lender won’t require you to show exactly where you got the money and where the gift-giver got the money from, Jones said. If you receive the gift closer to applying, the lender may require up to three months of bank statements from the gift-giver showing where the money came from, and they may even require the gift-giver to undergo a credit check.

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A gift may be used for the entirety of your down payment, closing costs, and cash reserves. Acceptable donors include a relative by blood, marriage, adoption, or legal guardianship; a fiance or fiancee; or a domestic partner. The required documentation will vary by lender and loan type, but, in general, you’ll need a gift letter signed by the donor stating the dollar amount of the gift, the date the funds were transfered, a statement that no repayment is expected, and the donor’s name, address, phone number, and relationship to the borrower.

“If you apply for a mortgage and your finances show that the majority of the funds you will use for the down payment just showed up in your account a week ago, it can be cause for concern if it doesn’t look like you could afford the property otherwise,” said Chris Taylor, a broker and investment property specialist with Advantage Real Estate in Boston. However, if the funds have been in your account for a few months, your finances look less volatile and the lender has less concern about your ability to pay.”

How do you broach the subject with your family?

“I recommend asking home-buying advice of the person you're hoping for a gift from,” Jones said. “The down payment conversation will naturally come out of this discussion.” 

In 2018, donors can give $15,000 to each recipient without having to pay gift tax. So, for example, two parents could each give a child $15,000, for a total down payment gift of $30,000.

Don’t: Sacrifice your retirement to buy a house

If you have a 401(k) plan, there’s a good chance you can borrow from it to help you buy a home. Assuming you don’t have any outstanding 401(k) loans, you can borrow, without paying tax on the borrowed funds, up to 50 percent of your vested account balance with a maximum of $50,000. You’ll have at least five years to repay the loan.

Borrowing against a 401(k) can be a great way to get a down payment, Schachter said. Borrowing rates are usually very low, and the lender doesn’t include the new payment from the loan in your debt-to-income ratio.

But Taylor advised against it, especially if you expect to change jobs in the near term, which may require you to repay the full loan balance immediately upon departure. Further, the biggest advantage of your 401(k) funds is the length of time they’re invested. “Taking out a large chunk to cover a down payment can take years and years to recoup and will set you back comparatively,” he explained. “It’s also an indicator that the property may be pushing you beyond your means.” (Learn more: Borrowing from your 401(k): The risks.)

Taylor offered two alternatives. In the very short term, pause contributions to your 401(k) and put that money toward your down payment. After closing, resume your contributions. Or, if you have a Roth IRA, you can withdraw up to $10,000 without penalty to buy your first home.

In addition, Roth IRA contributions, but not investment earnings, can be withdrawn penalty free at any time. When you take money from your retirement account in this way, you can never regain the lost opportunity to contribute those funds and earn a return on that investment. Roth IRAs don’t provide for loans, so you’ll need to weigh the opportunity cost of the lost investment potential against the opportunity cost of waiting to buy a home. And with 401(k) loans, people often don’t make new contributions while repaying their loan, which means not only are they not continuing to fund their plan, but they’re also missing out on any employer match.

Some traditional IRAs offer the ability to borrow up to $10,000 for a home purchase. In addition, some allow “rollover” loans where money can be withdrawn without penalty or tax for 60 days, as long as it’s paid back in time. Again, the timing risks and lost investment opportunities make such options inadvisable for most people.

If you have a permanent life insurance policy, there is also the possibility of tapping into its cash value. Here, too, are risks, as doing so will decrease the policy’s death benefit and cash value and increase the chances the policy will lapse. (Learn more: Treat life insurance cash value with care)

Final thoughts

Buying a home may not require as large of a down payment as you might think. Before you talk with a lender, you may want to consult a financial advisor about how much you can comfortably afford and how decisions such as paying more interest, paying PMI, or taking a loan or withdrawal from your retirement savings will affect your finances.

Armed with that information, you can confidently enter discussions with lenders about what low-down-payment mortgages you qualify for and how much you’re comfortable borrowing.

Learn more from MassMutual…

Saving for retirement in your 20s: Doing the math

Buying a house: What millennial homebuyers want

Life’s milestones: Delayed, but diminished?

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Zillow Research, “Down Payment the Top Hurdle Holding Back Would-Be Home Buyers,” April 12, 2017.

The information provided is not written or intended as specific tax or legal advice. MassMutual, its employees and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Opinions expressed by those interviewed are their own, and do not necessarily represent the views of Massachusetts Mutual Life Insurance Company.