House Shopping: Devise a Down-Payment Plan

If you're thinking about buying a house in the next year or two, you may wonder what you're getting into. Pervasive news reports about the "mortgage meltdown" are shaking home buyers' confidence. Confusion and questions abound, especially for first-time buyers.

One question on your mind may be about the down payment. How big a down payment do you need in today's lending environment? Once you have a dollar figure to aim toward, a second question surfaces: Where are you going to get the money?

American consumers are more concerned about having enough money for a down payment and closing costs than they have been in five years of polling, according to the 2007 National Housing Pulse Survey, conducted in October 2007 by the National Association of Realtors® (NAR), Chicago. More than 80% of survey respondents said down payments and closing costs are obstacles for home buyers in their area.

How much do you need for a down payment?

In 2006, 45% of first-time home buyers made no down payment when buying a house, according to NAR. Some of those zero-down-payment options, however, were attached to questionable mortgages that eventually got buyers into serious financial trouble�the subprime mortgages much in the news these past months. Those types of mortgages are history in the marketplace, although many homeowners remain mired in them.

You still may find some zero-down-payment mortgages available from quality lenders. Just expect to pay a premium in the form of a higher rate on the loan and/or higher fees, says Tracy Ashfield, executive vice president of Strategic Mortgage Solutions, Madison, Wis., a mortgage consultant to credit unions nationwide.

"That's why we stress so much to folks that it's important to accumulate some down payment," she says. "You'll get a more competitive mortgage product that will help you keep your monthly payments down." That will save you a lot of money in interest over the life of your loan.

Ashfield's No. 1 piece of advice to prospective home buyers these days is "to get good counsel. That's more important than ever." That counsel should come from someone who has a firm grasp of the overall mortgage scene and your financial needs�such as your credit union lender. "Sit down with your lender as soon as you possibly can," Ashfield advises, "even if you're a year or 18 months away from buying."

With your lender, you can go over your income, savings, other assets, and credit score. From there, you can figure out a reasonable down-payment goal.

"Maybe you've accumulated a 5% down payment," Ashfield notes. "Or maybe it makes more sense to pay 3% down and use some of your money to pay discount points to buy down your rate a little bit." (Discount points are fees you pay a lender at closing to reduce your interest rate. A point is 1% of the amount borrowed.)

Your best strategy depends on your complete financial picture. Your lender can help you select a down payment and other mortgage features that best fit your financial situation. (Note: If your down payment is less than 20%, you'll generally pay for private mortgage insurance, which protects the lender against losses. That adds to your monthly mortgage payment.)

"This is a time for buyers to be tuned in," Ashfield says. "Plan ahead, watch the market, and get good counsel. Don't fold up your tent and say, 'Oh, mortgage rates have gone up. It's all too confusing. I shouldn't buy a home.' Don't miss out on what may be a perfect opportunity."

To make sure you're prepared for that opportunity, be sure your credit habits are impeccable. Pay bills on time, every time.

Where will you get your down payment?

At first glance, saving for a down payment may seem insurmountable. But with lots of ingenuity�and perhaps a little sacrifice�you can build a down-payment fund. Here are some ways to do it:

Save your money. Set aside a certain sum out of every paycheck, before you get a chance to spend it. Payroll deduction or some other automatic savings plan at your credit union is an easy, trouble-free way to save. Also, put bonuses from your job and tax refunds and rebates straight into savings. Scrutinize your budget to see where you could trim costs. How much would you save in a year if you gave up that daily $4 latte? Could your family do without your second car? Could you live in a smaller, cheaper apartment for a year or two to save on rent? If you're having trouble spotting the extras in your spending, a credit union financial counselor can help by bringing a more objective eye to your budget.

Get a second job. It may make life a bit more hectic for a year or two. But you might feel it's worth it if it means being able to buy a home.

Ask for family help. Anyone can give up to $12,000 (this number adjusts annually for inflation) per year to another person, without federal gift tax consequences. In other words, your parents could give you up to $24,000 a year and, if you're married, another $24,000 to your spouse. You need not pay income tax on this money.

Borrow from family. The Internal Revenue Service (IRS) sets a minimum interest rate that a family member would have to charge you for the loan. Be sure you have a written, enforceable note that spells out the terms. A downside: Your lender may count this loan in your debt load in determining your mortgage eligibility.

Share equity. Under an equity-sharing arrangement, your parents could contribute all or part of the down payment, in return for a share in ownership of your home. Their names go on the title, along with yours. A downside: Disagreements among the various owners about whether to remodel or sell can be a problem.

Tap your IRA (individual retirement account). The IRS allows a first-time home buyer to withdraw up to $10,000 to use for a down payment ($20,000 if you're married and your spouse also is a first-time buyer). You pay no penalty for early withdrawal, but you may owe taxes, depending on the type of IRA. Don't withdraw too early, as you must use the funds within 120 days of withdrawal. See IRS Publication 590 for details or talk to your tax adviser.

Look at your 401(k). Check with your employer to find out if you can borrow from your company's plan. Remember, it's a loan; you have to pay it back. Be sure to continue putting money into your 401(k), too, so you can get your employer's match. Otherwise you're passing up free money.

Caution: If you use money from your 401(k), you're losing the benefit of compounding on the money you've borrowed. This can mean thousands of dollars�or more�over the years that you're repaying the loan. And, if you leave your job�at your discretion or your employer's�you must repay the loan in 60 days.

Look into first-time buyer assistance programs. You might be eligible for a state or local program that provides down-payment assistance to first-time buyers. Your lender may know of some of these, says Ashfield, who trains credit union lenders about how to find these special programs in their markets. "These programs are fabulous," she says, "but they're often hidden. You have to dig around and talk to people."

Published April 28, 2008