5 Options if Your Down Payment's Short

When it comes to life's frustrations, few are more agonizing than desperately wanting to buy a home when your savings fall short of the cash required for your down payment. True, a LendingTree survey earlier this year found lenders of some mortgages (not FHA-backed ones) loosening their standards, and accepting smaller percentages of purchase prices. But rising real-estate values are likely soon to erode those gains -- if they haven't already.

Meanwhile, those same rising prices, coupled with an upward drift in mortgage rates, are hitting home affordability, and making the dream of property ownership even more distant for many aspiring first time buyers. So what can you do to close the gap between your savings and your down payment needs?

1. Let Your State or Local Government Help

If you're a first time buyer (which is often defined as not having owned a home for three years or more) and / or earn a modest income, you may be eligible for help from your state, county or city. Sometimes, experienced homeowners also qualify, but generally only if they're buying in an area zoned for some form of regeneration. The U.S. Department of Housing and Urban Development's (HUD's) website has a page that lets you search for your local home-buying programs.

The problem with most of these programs is that they have a finite amount of money each year, which is allocated on a first-come, first-served basis. So, if you apply after that year's pot has been spent, you won't get your money until at least the following year, regardless of whether you meet the eligibility criteria. If you do receive assistance, it generally comes in one or more of three ways:

  1. An interest-only loan at a low rate. You have to pay the interest each month, but only have to repay the principal (the sum you actually borrowed) when your mortgage is "retired," in other words, when you sell your home or make your final payment on that mortgage.
  2. An interest-free loan. Again, it's generally repayable only when you retire your mortgage.
  3. A grant, which is effectively a gift to you.

2. Find Federal Funding

There aren't any federal programs that help home buyers in general with down payment shortfalls, but people in special circumstances may still receive help. For example, veterans and those still serving in the military are usually eligible for VA loans, which require no down payment at all.

If you want to buy a home in a designated rural area, you may qualify for a guaranteed housing loan from the U.S. Department of Agriculture, which again has no down payment requirements. However, you currently stand to get one of these only if your income is 115 percent or less than the median income for the area in which you hope to buy.

Then, there's the Good Neighbor Next Door program, which allows first responders, nurses and teachers to purchase HUD foreclosure homes at half price and with just $100 down. You have to stay in a qualifying line of work and live in your home for at least three years.

3. Cash In Your Own Assets

If you're serious about buying your first home or trading up, you may have to make some painful sacrifices. You may think your most prized possessions are indispensable and somehow define you, but are they more important than your desire to owning the property of your dreams? If you decide they're not, selling a sports car, boat, motorcycle, jet ski, collection of Fabergé eggs or whatever could make a big dent in your down payment shortfall.

Next, review your financial assets. It might be fine to sell taxable investments, such as bonds, mutual funds and stocks (don't forget any stock options you've accrued through work), but you ought to think very carefully before touching tax-efficient ones, especially 401(k)s and IRAs. There can be significant penalties incurred when those are sold, although there are exceptions. Take advice from a trusted professional before you act.

Be equally cautious if you're considering cashing in a life insurance policy. Some of these (not "term" ones) acquire value over time, and it's possible either to cash them in or borrow using them as collateral. This can work well if you have no dependents, but could later prove disastrous if you do.

4. Tap Your Family or Employer

If you have rich relatives, then a cash gift could be the answer to your prayers. Your lender will need a letter from your generous donor, confirming that your windfall is a gift, and not a loan, and a paper trail showing the money's journey from your donor's account to yours.

Many lenders are willing to allow you to borrow at least part of your down payment, but they're going to include the monthly repayments in their assessment of your disposable income. If you've got a great salary but low savings, this may not be an issue.

As well as rich relatives, check with your HR department whether your employer offers down payment loans to staff. These aren't common, but they do exist. If you're relocating to a new job with your existing employer or a new one, you may find your bosses especially amenable, even if there isn't a general program in place.

5. Drive Down Your Closing Costs

Closing costs are commonly two-to five percent of your sales price. If you can reduce or eliminate them, you could find your down payment shortfall greatly reduced.

Your seller isn't allowed to contribute to your down payment, but he or she can cover some or all closing costs. In addition, most lenders offer some sort of "zero cost" mortgage. You pay a slightly higher rate in exchange for the elimination of closing costs. That could prove expensive in the long term, although it's just possible that you could end up paying that same higher rate and those costs if you wait to save up and mortgage rates in general continue to increase.

You might also be able to shave hundreds or thousands off your closing costs by making sure your title insurance is appropriate, and by shopping diligently for your home loan -- compare mortgage quotes from several competing lenders and choose the one offering the best combination or rate and closing costs for your situation.

Keep Calm

Rising home prices and mortgage rates can be a lethal combination for renters who aspire to be homeowners. Assuming those conditions continue, it's worth trying any and all of the above options to try to bring forward the date when you can fix your rates and benefit from increasing property values.

However, it's not worth damaging your long-term financial health in order to meet this objective. So take advice from professionals. Real-estate agents and lenders can tell you about the financial assistance available to you, and insurance brokers, accountants and financial advisers can provide advice on the wisdom of cashing in certain assets. Talk to them. This is something you really want to get right.

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