Financing Options
Are you thinking about taking out a bank loan? Personal loans carry higher interest rates than mortgages. A personal loan will also increase your debt load in the same way borrowing on a credit card will. And a lender is likely to discover that you've taken out a loan to make a down payment, which will count against your total debt-to-income ratio as they calculate how much mortgage you qualify for.
According to the National Association of Realtors, in 2006, the average household income of buyers was $74,000.
Lenders often ask mortgage applicants to show proof that downpayment funds have been in a bank account for two to three months. (This is why you should liquidate assets as early as possible in your house hunting.) The lender wants to be assured the funds have not been borrowed from another lender. They also want to know the money you have for the house has come from a legitimate source, such as savings or the selling of some asset (another good reason to keep the receipts or statements handy).
More than 20 percent of all first-time homebuyers get some financial help from their parents or other relatives. Parents mean well when they contribute to a down payment fund, but be sure you know they have thought the matter through carefully. You don't want to let emotion get in the way of financial good sense. Be sure that Mom and Dad will not seriously miss that $10,000 for the short term. Does it hinder their plans? Will the money be a loan or a gift? If a loan, how soon do you need to repay it?
If your parents help you with the down payment, the lender will probably ask them to sign a gift letter stating the money is a present and does not have to be repaid. The gift letter has to be accompanied by a document that shows Mom and Dad do indeed have the money to give, usually a bank statement showing the donors have sufficient funds in their account.
If Mom and Dad's check represents a loan, lenders will factor in that repayment plan with your other financial obligations, and that is likely to reduce the size of the loan they are willing to offer. Indeed, some lenders will not make a loan if all of the buyer's down payment is borrowed.
If your folks do decide to help you, they ought to seek the advice of an accountant before writing a check. Gifts over $12,000 may incur additional taxes from the IRS. There may be ways your parents can structure gifts and loans to make them, if not advantageous, at least a little less painful for you at tax time.
If your parents, other family members, and even friends decide to gift you more than the allotted $12,000 annual basis the IRS allows, they can actually write it off their lifetime gift-tax exclusion, which presently is $1,000,000. — Scott Yonehiro
If you have exhausted your own resources and still don't have the money you need for a down payment, you may want to consider assistance from a government-backed homebuying program that calls for lower-than-normal down payments. The Federal Housing Administration (FHA) is a government agency that operates under the umbrella of the U.S. Department of Housing and Urban Development (HUD). (There is more about FHA-insured mortgages in Chapter 4. This section focuses on their downpayment requirements.)
With an FHA-backed loan, you can buy a home with a down payment of 3 percent. However, you will be required to pay their mortgage insurance, which will probably cost you 1.5 percent of the loan up front — it can be financed — and annual payments of 0.5 percent. These rates are designed to cut back on the number of problem loans to people likely to default on what they've borrowed. Private mortgage insurance with conventional loans (covered later in this chapter) also requires a monthly charge to the homebuyer, but there is no up-front fee. If you get a gift from a relative (or anyone else) that goes toward your down payment, under FHA rules that gift can even extend to covering your closing costs. For more information about FHA loans, call (800) 483-7342 or visit
Your lender can help you with all of these programs, although depending on where you live, he may not be familiar with the FmHA. You can also call those agencies direct. Remember, the FHA operates under HUD, which has regional offices; the VA has local and regional offices; and the FmHA operates under the U.S. Department of Agriculture.
If you qualify for a loan from the Department of Veterans' Affairs (VA), you do not have to make any down payment. These loans are available to veterans or widows or widowers of veterans who died of service-related injuries. Closing costs can be covered by a gift in this case, too.
The Federal Farmers Home Administration (FmHA) may not be a house-hold name, but it can make a homeowner of you. If you are looking to buy a home in a rural area, the FmHA offers no-down payment programs and lower-than-market interest rates. Here's the catch: The house you buy must meet their definition of rural, and it must be your principal residence (no second homes allowed here).
Every state offers some type of homebuying program for first-time buyers featuring low-down payment requirements and lower-than-market interest rates. Money is available through bond programs, which are handled by quasi-autonomous agencies known as mortgage finance agencies, housing finance authorities, or something similar.
There may be an income ceiling for those wishing to buy through this program, and you will likely be restricted to certain areas of some towns — and even to certain blocks within those areas. The program is only for firsttime buyers or those who have not owned a home for a specified number of years, usually three or five. But the program works! People who otherwise might not be able to come up with the financing to buy a home become proud homeowners with the help of their state agency.
However, this program regularly seems to be in danger of disappearing for budgetary reasons. Also, when bond money appears for mortgage financing, it disappears quickly, so you'll want to keep an eye on the program and its disbursements. To learn more about this program, contact your governor's office for the name and phone number of the mortgage finance agency in your state.
In addition to government-backed programs, there are a few lenders who will allow a mortgage with a 5 percent down payment — for those with assets and very clean credit. In addition, in tough economic times, some developers of new-home communities will advertise a 5 percent down payment. Sometimes that offer is made for only a short time, to help get a particular development off the ground. Developers will also sometimes, usually in certain tight economic markets, offer houses and condos under a lease/ purchase plan.
A developer can offer a lease/purchase plan to a buyer, but more often it is the seller, not the buyer, who accepts this plan, which allows you to rent with the option to buy at the end of a specified period of time. Here is how the plan works, although there can be any number of variations: You rent a house or condominium, signing a contract that states that at the end of six, twelve, or eighteen months you will be given the option to buy that property at a price set at the signing of the contract. (But make sure that your lease/purchase contract stipulates whether you are allowed to buy the property or whether you must buy the property.) This contract protects you from ordinary price increases in the housing market each year. Additionally, the seller, who for the moment will be your landlord, allows you to apply some of your rent money toward the purchase. The rent you pay goes toward your down payment at the end of the rental period. It is a good idea to have a real estate attorney review this contract as well.
Try to negotiate as much as possible of that rent toward your down payment. If the owner offers 20 percent, try for 50 or even 100 percent of it. Naturally, there should be a written agreement between all parties to seal the pact and spell out specifics.
The lease/purchase plan can work well with new-home developers who are anxious to sell their properties and do not mind renting them initially, with the proviso that the tenant will eventually buy. You should know that your option money will not be refunded if you elect not to buy at the end of the specified time. Unless you can prove some sort of fraud on the part of the seller, you do not have any legal grounds for getting that money back — it must be applied toward the purchase of the house.
Where do you find properties you can lease first?
Check the Houses for Rent and Houses for Sale classified pages of the newspaper in the town you are looking in. Contact the owners and, especially in a sluggish market, you may well come up with a home for yourself.
If the real-estate market goes down, you can decline to exercise your option to buy, a move that could be wise over the long term, even though it will mean forfeiting the option money. As with every real-estate deal, everything in a lease/purchase plan is negotiable, from purchase price to such details as maintenance of the property while you are renting.
Renting that leads to buying can be an excellent path to homeownership, but do not waste your time trying to make such an arrangement work in a booming sellers' market. Sellers will not have any incentive to rent first when they can sell right away to someone else. However, in an active buyers' market, where house hunters can pick and choose from a large pool of properties, sellers are likely to be more open to a lease/purchase plan. Sellers might also be interested in this plan if they are in a hurry to move and want to sell their property fast.
