So many in America desire to become home owners. They know that home ownership is the most likely path towards financial security for their family as well as freedom from the tyranny of landlords. Indeed, Federal Reserve Board studies have shown that owners have a net worth many times that of renters. The goal of owning not only promotes financing security, but also promotes stability and the freedom of choice.
Why don't more Americans purchase a home?
There are many obstacles on the road to achieving home ownership but studies by mortgage giant Fannie Mae have shown that the clear number one obstacle is the lack of liquid assets. Many Americans have the income and credit to qualify but amassing savings is difficult in this day and age. Some of this is misinformation on the part of those who don’t own a home. Many feel that it takes tens of thousands of dollars in cash to purchase, but that is not always the case. The purpose of this article is to look at alternatives that lessen cash requirements plus give potential homebuyers ideas of where to come up with the necessary capital to purchase their first home or perhaps move up from their present home.
Lower down payment programs. There are specialty programs which lessen or even eliminate the need for a down payment. For example, the VA Mortgage Program requires no down payment but is open only to active military and veterans, as well as reservists and those who have served in the National Guard. In less populated areas the USDA Rural Housing Program also requires no down payment. The Federal Housing Administration (FHA) Mortgage Program requires only 3.5% down and is accessible to all buyers who do not have a present FHA mortgage. There are also 3.0% down conventional mortgage programs for low-to-moderate income borrowers. For example, 3.0% down on a $300,000 sale price is $9,000. Zero down to 3.0% down? That is lower than most expect before they start their search for their first home.
The next question is, where can this money come from, especially if you don't qualify for VA or a Rural Housing Loan?
Here are two important alternatives.....
Gifts. Typically a gift from an immediate relative is allowed for a purchase transaction. FHA and VA Programs allow what is called “100% Gifts.” This term means that the total cash necessary for the transaction is allowed to come from a gift. Some conventional programs also allow 100% gifts, but others may require the applicant to have 5.0% of their own money contributed towards the transaction.
Borrowing Secured. Another fact not widely known by real estate agents and home shoppers is that the home purchaser can borrow the money necessary for the down payment secured against an asset. For example, if a person owns a home with equity, they can take out a second mortgage in order to purchase another home. Of course, first time buyers don’t own a home, so the question is — what kind of asset can they borrow against?
The 401K Advantage. By far, the greatest asset owned by those who are renters is their retirement accounts. General mortgage lending rules allow a person to take a loan against their 401K to purchase a home. Even better, in some situations lenders may not count the payment for this loan when computing qualification ratios. Note that all types of retirement accounts do not necessarily allow the ability to borrower against the asset. But even if you can’t borrow against the account, you could remove funds to purchase a home. Even though there will be a tax penalty (except in the case of a Roth IRA), this penalty can be outweighed by the tax benefit of home ownership in the long run.
It should also be noted that your retirement account will be counted as an asset for required reserves even if you don’t remove the funds, though there will not be a dollar-for-dollar credit because of the cost of removing funds.
What about closing costs associated with purchasing a home?
While it is true that purchasing a home comes with transactional costs, you can use the two strategies above to pay these costs, plus you can use the following two additional alternatives as well…
Seller Contributions. Some or all of the money needed for closing costs typically can be paid by the seller in a purchase transaction. On VA loans, the seller can pay all closing costs. On FHA loans, the seller can pay up to 6.0% towards closing costs. On minimum down payment conventional loans, the seller can pay up to 3.0% of the sales price towards closing costs. It is important to negotiate these “seller concessions” before the contract is ratified.
Lender-paid closing costs. Lenders now offer mortgage alternatives which lessen the cash needed to purchase. For example, the purchaser can opt for a higher rate, no-point mortgage which in fact lessens closing costs. An even higher rate may mean that the lender can advance a credit for additional closing costs associated with the home purchase. In effect, the purchaser is financing their costs through a higher rate.
Not to be outdone, mortgage insurance companies have offered an option which has helped lessen cash requirements. Conventional mortgage insurance in the past required an up-front cash payment of more than one percent of the sales price. This option allows the monthly payment to be increased and eliminates the up-front cost. As an alternative, the lender may be able to fund all mortgage insurance costs through a higher rate. This alternative is called “Lender Paid Mortgage Insurance” and has the secondary benefit of typically making the insurance cost tax deductible for primary residences.
In summary, there are many ways for a lender to help you lessen or even eliminate the up-front cash needed to purchase. If you are interested in purchasing a home with the minimum cash required, contact me for more details regarding these alternatives.