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Buying a home can be a significant milestone in your life, but it's also a major commitment, both in terms of upfront and long-term costs. In most cases, you're required to make a down payment on your purchase, with minimums ranging from 3% to 20%, depending on the loan.
And while there are home loan programs with no down payment requirement, it's still a good idea to put some money down to avoid being underwater on your mortgage if home prices fall.
All that said, mortgage lenders may restrict the type of money you can use for a home down payment. Here's what you should know.
How to Come Up With Your Home Down Payment
If you're trying to figure out how to come up with your down payment, it's important to know what you can and can't use.
For example, it's possible to use a second mortgage, a piggyback loan or even a loan from a friend or family member, but you can't use a personal loan or a credit card cash advance. Whenever you borrow for a down payment, however, be sure to keep an eye on how it impacts your debt-to-income ratio, which is something your lender will consider when approving your loan.
Here are some of the sources of down payment funds that are typically acceptable among mortgage lenders.
It can take several years to come up with enough cash for a down payment, but that's what most younger buyers tend to do, especially if they're first-time homebuyers and don't have equity in an existing home that they can use. Having enough cash on hand to easily cover your down payment, closing costs and any additional expenses can also make you a more competitive homebuyer.
Proceeds From the Sale of Your Existing Home
If you're a homeowner, you've likely built equity in your home as its value has appreciated and you've paid down your loan balance. When you sell your home, you can put some or all of this equity toward your next home, reducing or even eliminating the need for other down payment sources.
Just keep in mind that, in some cases, sellers may need to pay taxes on some or all of their profit from the sale. To avoid taxes, you need to live in the home for at least two out of the last five years. Additionally, the exclusion is limited to $250,000 for single taxpayers and $500,000 for taxpayers who are married and filing jointly.
Gifts and Loans From Friends or Relatives
According to the National Association of Realtors, 28% of younger millennials used a gift or a loan from a friend or family member to purchase a home in 2020.
There's no limit on how much you can use from gifts and loans for your down payment, but some loan programs require you to have a minimum borrower contribution. This means that you need to source a certain amount of your down payment from your own funds. The minimum borrower contribution will vary from program to program, and some don't have one at all.
Again, you'll want to consider how your new debt obligations impact your ability to secure the loan if you plan to borrow. If you're receiving a cash gift, your lender may require you to submit a letter that states you're under no obligation to repay the gift.
Down Payment Assistance Programs
There are many local and national programs available that can help you meet some or all of your down payment requirements. They're typically offered by lenders, community organizations and government agencies, and they're usually only available to first-time homebuyers.
The terms of the down payment assistance can vary, depending on the organization providing it:
- Grant: Grants are the best form of down payment assistance because you don't have to pay the money back.
- Forgivable loan: With this type of second mortgage, you don't need to repay the money as long as you meet certain conditions. For instance, you may have the loan forgiven if you remain in the house for a minimum amount of time—five years is typical, but the requirement can be longer. You'll need to repay the loan if you break the terms of the loan, which may occur if you move, sell the home or refinance your loan before the forgiveness period ends.
- Low-interest loan: This second mortgage must be repaid along with your first mortgage, but it typically comes with a low interest rate for better affordability.
- Deferred-payment loan: Similar to the forgivable loan, you don't have to start making payments on this loan immediately, and there's typically no interest rate. That said, you'll have to repay this type of loan if you move or sell your home or refinance your mortgage. There's no option for forgiveness.
- Matched savings program: Also known as individual development accounts, these programs will match savings you've already come up with to increase your total down payment. You typically don't have to repay this money. Many programs offer a one-to-one match rate, but some will give you more.
Home Equity or Piggyback Loan
If you're not planning on selling your current home, you won't have proceeds from the sale. That said, you can take out a home equity loan and put that money toward buying a second home.
There's also an option to use what's called a "piggyback loan." This is a specialized second mortgage loan that you can take out along with your first mortgage and a down payment, specifically with the goal to avoid mortgage insurance or having to borrow a jumbo loan.
Mortgage insurance is often required on mortgage loans if you don't put down 20% or more, and many lenders require the same on jumbo loans that exceed the conventional conforming loan limits. So, you may put down 10% of your own money, take out a piggyback loan for another 10% and borrow the remaining 80% using a first mortgage.
Keeping Your Credit in Tip-Top Shape Is Crucial
The more money you can put down on your new home, the less you'll have to borrow. This not only ensures that you'll have a lower monthly payment but it can also help you qualify for a lower interest rate.
That said, your down payment is just one piece of the puzzle when you're trying to get a mortgage loan. Minimum credit score requirements can vary from program to program, but the higher your credit score is, the better your chances will be of securing a low interest rate. Even a small reduction in the interest rate could potentially save you thousands of dollars over the life of your loan.
As such, it's essential that you take the time to build your credit history before you start the mortgage process. Start by checking your credit score and reviewing your credit report to learn how well your credit history stacks up and take steps to address potential issues. With an Experian CreditWorks℠ Premium subscription, you can view the same credit scores lenders use, which will equip you well to take action to get the best rate.