When working to save money for a down payment on a home, start soon, weigh your loan options, explore other funding options and consider using home equity.
LOS ANGELES — Saving up for a down payment is the biggest hurdle for many would-be homebuyers, particularly those looking to make the leap from renting to owning.
Here are some tips to consider when working toward that down payment:
1. Start soon
Begin saving now. Renters may want to calculate what their extra monthly costs would be as a homeowner and then set aside that amount, minus rent and utilities. This accomplishes two goals: Saving money for a down payment and getting you accustomed to the financial constraints of living with the costs of homeownership.
Another strategy that may help: open a separate savings account just for your down payment. That will help lessen the temptation of using the funds for something else.
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You’ll also have to set aside money for closing costs, which can run into the hundreds or thousands of dollars.
2. Weigh loan options
The type of home loan you get may determine how much of a down payment you need. For many years, buyers sought to put down 20 percent of the purchase price. That would lower their monthly mortgage payment and allow them to avoid having to pay for private mortgage insurance, or PMI. But as home prices have risen, that trend has waned. Loans that require as little as 3 percent up front have become more common. As a result, the median U.S. down payment has declined to 10 percent the past four years, according to the National Association of Realtors (NAR).
Lenders offer loans backed by government mortgage companies Fannie Mae and Freddie Mac that require only a 3 percent down payment. Borrowers can ask to have their PMI waived once the equity in their home reaches 20 percent.
Borrowers with less-than-sterling credit may have a better shot qualifying for loans backed by the Federal Housing Administration. The FHA’s program requires 3.5 percent down, but borrowers have to refinance once their equity grows above 20 percent in order to get out of paying PMI. Until then, PMI is tax-deductible.
Buyers may not need to save for a down payment at all if they are U.S. military veterans, service members or residents of certain rural areas. The Department of Veterans Affairs and the U.S. Department of Agriculture have zero-down-payment loan programs for qualified borrowers.
3. Explore other options
Saving for a down payment sometimes takes more than cutting back on dining out or travel. A quarter of first-time homebuyers in 2016 used gift money from relatives or friends to round out their down payment, according to the NAR. And more than 10 percent tapped their retirement savings without the usual hefty penalties for an early withdrawal. Of course, before withdrawing money from your 401(k) or IRA accounts consider that a big withdrawal will mean your retirement savings won’t grow as swiftly.
Borrowers with low or moderate income, and teachers, firefighters or other public-service job holders, may also qualify for down-payment assistance through thousands of federal, state or local programs aimed at helping homebuyers.
There are more than 2,100 funded programs, many of which help cover the down payment and closing costs through loans that can sometimes be forgiven over time, or paid back only once the buyer sells the home, according to Down Payment Resource, a tracker of homebuyer assistance programs.
4. Consider using home equity
A newer approach to coming up with a down payment involves letting investors put up some of the money in exchange for a slice of the potential value in the home.
San Francisco-based Unison now has a program available in 12 states — including Washington — and the District of Columbia that offers to match up to half of a 20 percent down payment on a home. The match isn’t a loan, in that the buyer doesn’t have to make payments, but still benefits from the lower cost of making a 20 percent down payment.
There are several payback scenarios, but essentially the company collects a 35 percent share of the gain, if any, in the sale of the home. Should the home decline in value, the company shares in the loss, potentially receiving less money back on its investment.
“There’s a very clear trade-off here in that you are surrendering future equity,” said Greg McBride, chief financial analyst at Bankrate.com, noting that home equity is increasingly becoming Americans’ principal way to fund their retirement. “So, look yourself in the mirror and make sure that you’re not potentially shortchanging your future financial security just to get into a slightly more expensive home now.”