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Down Payment Lowdown

Let me start the inaugural post of In the Weeds with Lee by addressing a misconception from Annelle’s latest blog, “Avocado Toast and the Millennial Mortgage.”  You don’t need a college degree to purchase a home. You probably will need a down payment and Annelle is right – it is easier than you think to get into that first home. There are many options and a great deal of people to help you purchase that first home.

So let’s get in the weeds – because the sharks are always in the details.

» Down Payment Lowdown

There is a common misconception that you must have 20% down to purchase a home. Fannie Mae, Freddie Mac, and Federal Housing Authority (FHA) all have programs that require as little as 3% (first-time home buyer) down plus your closing costs. U.S. Department of Agriculture (USDA) and U.S. Department of Veterans Affairs (VA) require even less if you qualify for their programs.

USDA is my favorite in that their program is focused on purchasing in rural areas where you can get home with land for your pooches and kitties (or goats, chickens, even Alpacas if that is your preference) and you might only pay for closing costs.

But if you prefer city life here are some possible options for pulling together that “down”:

» Down Payment Assistance Programs

These are also known as DPA or sometimes DAP (we lenders are so clever with our acronyms). A DAP is designed to help people purchase homes with limited funds for a down payment. There are both private and government agencies which support these programs. Oregon.gov has the best list I found. At the time I wrote this, there are 17 agencies offering assistance with the financial end of purchasing a home. In addition the City of Portland has a program (as does nearly every county in the state to one extent or another). From my research, I found programs that offer as much as $15,000 to help you with your down.

There are DAPs that suspend repayment to the future, ones with no or very low interest, and some that will forgive the debt over time. These programs are intended to help those who want to enter the housing market but don’t have the funds to meet the down payment requirements. The best thing is they really want to give out money, as that is their measure of success.

» Gifts of Money

Gifts towards a down payment are very common. The “gifter” must have a close relationship with the “giftee” and must be willing to put in writing that the funds do not have to be repaid.

So, who can give you a gift? Well that depends on what type of mortgage you obtain. Fannie Mae states the following:

A gift can be provided by:

  • a relative, defined as the borrower’s spouse, child, or other dependent, or by any other individual who is related to the borrower by blood, marriage, adoption, or legal guardianship; or
  • a fiancé, fiancée, or domestic partner.

FHA says pretty much the same but they also allow gifts to be from an employer, labor union, and a charitable or government agency.

The differences noted above is a good illustration of the importance of finding the right loan for your situation. For example, it may be that conventional financing is better but FHA offer opportunities that improve your changes of purchasing that home. The point being that working with your lender to find the mortgage that is right for your specific situation is the key to success.

One other noteworthy point – despite what Fannie, Freddie, or any of the government lending agencies require, your lender may have additional requirements. In the lending industry these are called “overlays.”  Curious to know more? One of my future blogs will discuss overlays in more detail. But the key thing to remember is this: loan requirements are explained to you by your lender and you should know which ones (if any) are overlays. If there are any, and they work against you making your purchase, simply find another lender who doesn’t have these overlays. Asking this question will also tell your lender that you have done your homework.

In most cases, you can use the gift money to pay for everything you need to get into your new home. In other words, if you are purchasing your primary residence and it is a one unit property you don’t have to use any of your own funds. Multi-unit properties and rental properties have different rules.

One more thing about gifts…Who cannot gift you money for a down payment? Anyone who has in interest in or will benefit from selling you this home. Obviously that means the seller, but it also includes a builder, realtor, loan broker, etc.

» Borrowed Funds Using an Asset

Annelle mentioned borrowing the funds against your automobile. This is a good idea as long as the loan is secured by an asset. Assets include: savings accounts, automobiles, collectibles, stocks and bonds, or anything where an independent value can be determined. Unfortunately, advances on your credit card or loans with no collateral (aka unsecured loans) are not acceptable.

Keep in mind, this new loan payment will be included in qualifying you for your mortgage. The lender calculates what is called a debt-to-income ratio. Which is your total monthly payments (including your new mortgage) divided by your gross income. This is called your DTI – another term to know when getting your mortgage. The lender will ask where your down payment money is coming from. When you tell them you borrowed the funds using your whatever, they load that payment into your total monthly payments.

» Borrowing against your 401k or IRA

This can be a good source of a down payment. However this source is a little tricky but it will get you closer to “adulting” (is that really a word?). What do I mean? Well, withdrawing or borrowing from a 401k or IRA to purchase a home can have tax implications. As someone who has been “adulting” for over 40 years, I have learned that when dealing with taxes it is better to know in advance than to hope you read the rules correctly. My advice: if you want to use a pre-tax account for your down payment, contact a tax advisor. Even if they tell you what you already figured out, at least you have someone to fall back on with the other tax questions you are going to have.

Here is the best thing about using financial assets for collateral: Unlike the loans I discussed above, the payment from that loan does not get factored into that DTI which improves your chances of qualifying.

Here is what Fannie Mae says:

When qualifying the borrower, the lender must consider monthly payments for secured loans as a debt. If a secured loan does not require monthly payments, the lender must calculate an equivalent amount and consider that amount as a recurring debt. When loans are secured by the borrower’s financial assets, monthly payments for the loan do not have to be considered as a long-term debt.

This is true for FHA as well. Yahoo.

» Interested Party Contribution

Annelle’s post mentioned that the seller can contribute up to 6% of the sales price to your closing costs. This is called an Interested Party Contribution (IPC) and it not only applies to the seller but also the real estate agent or a builder/developer. You can use IPCs towards closing or financing costs. They cannot be used to meet down payment or minimum contribution requirements. IPCs are very helpful to get you into that first home but there is a catch.

There are limits to the contribution amount which is based on the sales price of the home. Conventional loans (Fannie Mae and Freddie Mac) set limits based on the loan amount to the sales price of the home. This is called the loan-to-value (LTV).

Greater than 90% 3%
75.01% to 90% 6%
75% or less 9%

For example, when the LTV exceeds 90% a maximum IPC percentage of 3% is applied. So if the home you are buying is $380,000 and your loan is more than $342,000 ($380,000 x .90 = $342,000) the maximum IPC would be $11,400 ($380,000 x 3%). If your LTV is 80% then the IPC goes up to 6% or, in this example, $22,800. On the other hand, FHA limits the IPC to 6% regardless of LTV.

So, that is the In the Weeds version of Annelle’s latest blog. There are many variables to consider when finding your mortgage. This is why finding the right loan officer is the first key step. I can vouch that Annelle will be a great asset for you. At Clackamas, we work to improve people’s lives and help them achieve their financial goals. For that reason, we will be glad to help answer all your questions. We’d love to help you learn how to get the right mortgage for you.

Have more questions? Annelle and I are teaching a Mortgage Myth Busters workshop in June. You can click here to register for this free event. We look forward to seeing you there!

By Lee Trumble, Real Estate Manager, NMLS# 1633149