I speak with a lot of prospective homebuyers and nearly always get the question “where can my down payment come from”? It’s a good question because there are specific sourcing requirements regulated by underwriting guidelines with FHA, VA, USDA, and conventional financing. Down Payments, next to income sourcing, cause the most headaches. Below is a general idea of where the down payment for your home can come from.
Income Tax Refunds
This time of year is notorious for people thinking of buying a home largely due to anticipated tax refunds. Tax refunds open the doors for paying down large chucks of debt and/or putting at least the minimum down payment up for buying a home. This is an acceptable source of funds for down payments.
However, you should have these funds in your possession before you shop for a home. Unfortunately, you risk deposits and money paid up front for services like a home inspection and appraisal if you start shopping too soon.
401k Loan & IRA accounts
If your company offers a 401k retirement plan, you should be contributing to it every paycheck. Over time, your vested balance builds and helps create some sense of retirement savings. The majority of plans allow you to borrow against your 401k, creating opportunities to consolidate debt at a lower rate or fund the down payment needed for purchasing a home. Every plan is different, but typically you can borrow up to 50% of your vested balance. Many homebuyers I speak with do not realize the power of this asset.
Your payments on the loan come directly from your paycheck each pay period and are based on a loan term you set. In addition, there is no credit check for this loan, and it does not count against you when calculating how much you qualify for because the money borrowed is secured by the balance. The downside to this is most of the time, the money your loan is backed by may not be invested in the market, causing you to lose earning potential.
The IRS allows a one-time first-time homebuyer penalty free withdrawal from your traditional IRA account of up to $10,000 for a down payment to purchase a home. You will likely pay taxes on the money withdrawn, but not the 10% penalty for being less than 59 1/2. Visit the IRS site for more details.
Many people are surprised to learn that a family member or spouse can gift you the funds needed for the down payment to purchase a home. If purchasing a primary residence, that gift can be 100% of the funds needed when it’s a FHA, VA, USDA or conventional loan. Jumbo financing allows a gift of funds, but usually 5% of the funds needed must come from the borrower.
If you have a family member willing to gift you the down payment, make sure you speak with your Loan Officer about how they should transfer the funds. The paperwork gets tedious if you do not follow instructions and can cause anxiety for the donor. For information concerning taxes & gifts, consult your tax preparer.
Your Money Saved & Small Business Account
Funds that have been seasoned more than 60 days in a bank account can be used for the down payment on a home. The bank views this as a compensating factor when determining your loan eligibility. It does not mean you will be denied a loan with the other forms of down payment. Simply that the bank considers your ability to manage money in your favor for having saved up to buy a home.
If you are self-employed, your business funds can be used as a down payment for a home. Certain requirements must be met for this to work. But it is possible.
Cash on Hand
Probably the most common question we get is “can I use my mattress money for the down payment”? The majority of the time the answer is no. However, if we can show a pattern of cash withdrawals that add up to the cash you have on hand, then yes, it is possible to use cash on hand. Certain requirements must be met such as reviewing 12 months of bank statements (or more) to “find” the cash withdrawals.
Trust me, it’s much better to have the other methods serve you with the down payment than this option. I’ve done it before, and it was extremely time consuming for both the borrower and the underwriter.
1031 Exchanges & Equity on Sale of Home
A 1031 exchange is a tax code that allows the Investor to use the equity of the sale of a home (usually investment property) as the down payment on another home (usually investment property) to avoid paying the capital gains tax on the equity. In cases where a borrower is selling their primary residence home and the equity is above the maximum allowed where taxes would be due, they can also do a 1031 exchange on the home they are buying.
Most homebuyers won’t need to consider a 1031 exchange. Yet, there are many circumstances you may decide to sell your current home and use the proceeds of that sale to purchase another home. You may do this in a simultaneous closing scenario, meaning you do not need to have the cash in your account right away. Certainly, your Real Estate agent will need to help prepare you accordingly. But this is an option if you own a home and still need cash for purchasing a home.
The list can actually go on with down payment types and sources. This is a good chunk of the opportunity where a borrower might consider coming up with a down payment. The amount of down payment needed will be discussed in another post but depends on the loan program, type of loan, investor requirements etc. In addition, not mentioned are Down Payment Assistant Programs. For now, use this as a general guide for understanding where you might be able to come up with a down payment. Reach out if you have a scenario for us to run by!