Down Payment Assistance Programs

Should You Use Your 401(k) for Down Payment?

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If you don’t have money to put down on a home, but you have a sizeable 401K account at work, you may consider using that money for your down payment. While you probably know that withdrawing the funds prior to retirement results in a penalty and taxes, there is a way around it. You may be able to borrow the money from your 401K to purchase a home.

Keep reading to learn how this might work.

Borrowing Money From Yourself

Essentially, when you borrow money from your 401K, you borrow money from yourself. Keep in mind that this is a loan with interest and due dates. The difference between a 401K loan and withdrawal is the penalties and taxes. When you borrow the money, you don’t pay penalties or taxes. When you withdraw funds, you do, but you don’t pay the funds back.

Before you start, though, you’ll have to make sure that your employer allows 401K loans. Most employers do, but some don’t. In general, most companies allow you to borrow up to 50% of your vested balance. So if you have $50,000 fully vested according to the company’s terms, you could borrow up to $25,000 for a down payment.

Paying the Loan Back

Just like any other loan, you must pay the 401K loan back in full. Because each company has different rules, you should check with your plan sponsor to see the exact terms of your loan. Typically, you have up to five years to pay the loan back (plus interest). If you leave the company (either voluntarily or involuntarily), you have a short amount of time to pay the loan back in full (typically 60 – 90 days).

The amount you pay back will include interest. Typically, you pay 2 points more than the current prime rate in interest. This interest doesn’t go to a bank though; it goes directly into your 401K account. Consider it the funds to make up for the money you would have made had you left the funds in your account to grow.

Does the 401K Loan Affect Your Debt Ratio?

A large part of your mortgage application is your debt ratio. This is a measure of your current debts to your gross monthly income. Lenders look at debts like your installment loans, mortgages, and credit card loans. If you borrow the money from your 401K loan, though, they will need to include that payment as well since it’s a debt you have to pay back.

If your debt ratio isn’t close to the maximum allowed for each loan program, you may not have anything to worry about. However, if your DTI is close to the maximum allowed, the 401K loan might put you over the edge, making it harder to get approved.

Is it Smart to Use Your 401K?

Even if you know you can borrow from your 401K account, is it right to do so? Some people have no problem borrowing from themselves, knowing that the interest they are paying is going right to them and not to a bank. But, there are some things you may want to consider before doing so.

First, ask yourself, do you need the down payment? If you have no money of your own for the down payment, you may not have a choice but to borrow from your 401K unless you are eligible for a 0% down payment loan, such as the USDA or VA loan. If you have some money, though, and it meets the minimum requirements for the loan program, you may want to leave your 401K alone.

You should also consider your other options, even if you don’t have any money to put down on the home. Have you exhausted any gift options or looked at down payment assistance programs in your area? If you haven’t, you should consider exhausting all available options to you so that you can leave your 401K alone if possible.

While a 401K loan is possible, it shouldn’t be your first option. Make sure you look at all other options to determine if you can get the money you need for a down payment elsewhere. If you can’t and you need the 401K loan, make sure you understand the terms and the maturity date so that you can make good on the loan.

Seasoning Guidelines for Your Down Payment

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When you make a down payment on a home, you can’t just use random money to make it. Lenders need to know where the funds originate. In other words, they need the funds to be seasoned. Just what does that mean and how do you prove it? Keep reading to learn all about it.

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What are Seasoned Funds?

Lenders will ask to see your bank account statements for the last 60 days (2 statements). On these statements, they will look for large down payments that don’t’ coincide with your income. If there are large deposits during this time, you can expect the lender to inquire about the source of the funds.

If a lender asks about the deposit, you need to provide proof of where the funds originated. For example, did you get a tax refund or a bonus from work? Those funds are easy to prove and typically acceptable with a lender. If you can’t prove the origination of the funds, though, the lender may assume that the money is from a loan. Lenders cannot accept down payment funds that come from a loan. This affects your debt ratio and your ability to secure the new mortgage.

What’s the Problem With a Down Payment Loan?

Many lenders shy away from borrowers that have to borrow the funds to put down on a home because it puts another lien on the home. If you don’t have any of your own money invested in the home, you pose a higher risk of default. What if you run into financial trouble? Will you care if you walk away from the home? If you didn’t have any of your own money put down on the home, it may be easier to just walk away from it.

Proving Your Funds are Seasoned

So how do you prove that you have seasoned funds? It’s simple – have them in your account for at least two months. Lenders are comfortable with this method because if you did in fact take out a loan for the down payment funds, it would show up on your credit report within that 2-month period. Even if your funds are ‘seasoned’, you can’t hide the loan from the lender.

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Now, what about funds that are legitimate, but may not be seasoned? There are a few exceptions to the rule:

  • Regular contributions to your savings – If you have payroll deductions or other automatic savings plans set up to create your down payment, you don’t have to wait 60 days after you hit the down payment threshold. You can show the lender your pattern of regular savings contributions, which is usually enough to consider the funds seasoned and available for use.
  • Gift funds – If you have a family member or close friend that is giving you gift money for your down payment, you don’t need to wait 60 days after you receive the funds. You do, however, have to have a paper trail to show that the funds are a gift. This includes a gift letter from the donor, proof of receipt of the funds with a deposit ticket, and proof of deposit in your own account.
  • Retirement funds – If you use your 401K or IRA savings to put money down on a home, you don’t have to season those funds either. Again, you’ll need that paper trail to show lenders where the money came from and whether or not it’s required to be paid back, (401Ks usually have to be paid back).

Have Explanations

The best thing you can do if you have unseasoned funds is have an explanation for the lender. Anything that you can put in writing and include proof of the origination of the funds will help. Lenders are going to scrutinize every deposit you make unless they know it’s tied to your income. The more proactive you are with supplying the proof of its origination, the better your chances of the lender accepting it.

Your explanation must be detailed and truthful. Again, the paper trail speaks for itself. It gives the lender something to rely on rather than just your written word. If you have a decent explanation of the origination of the funds and it’s clear that it’s not any type of loan, you may be able to get away with using it for your down payment.

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What Does Seller Assist Mean?

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If you don’t have enough money for a down payment on a home, you may wonder about the seller’s ability to help. While the seller can help with many different costs regarding your home purchase, the down payment is not one of them. If a seller were to help you with the down payment, it could be considered an inducement to purchase – or in other words, a bribe.

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What’s an Inducement to Purchase?

If you are hemming and hawing about whether you want to buy a home or not, the seller could sway you by telling you he will help with the down payment. That could convince you to buy the home, even if it wasn’t your original intent. If you meet with financial difficulty down the road, you could blame it on the seller and the fact that he ‘bribed you’ to buy the home.

Other Ways Sellers Can Help

Luckily, there are other ways that sellers can help you with your loan. If you can’t get a down payment, consider the VA or USDA loan program. If you are a veteran, you can use the VA loan program, if you buy a home in a rural area and are a low to moderate-income family, you can use the USDA program. If neither of those options work, the FHA loan requires just 3.5% down on the home.

Once you figure out your loan program, you can have the seller help you with the closing costs. This is called seller concessions. This is money the seller gives you to help you cover the closing costs. Most loan programs allow the seller to contribute up to 6% of the sales price of the home. This is separate from the down payment, though. The seller can help you cover any lender fees as well as third-party fees. Keep in mind, though, the money the seller gives you is really money you are borrowing from the bank to buy the home. The seller increases the price of the home accordingly, which means you borrow the money to cover the closing costs.

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Here’s an example:

You agree to buy a home for $150,000. Before you sign the contract, you decide to ask the seller to help you with the closing costs. The total closing costs are $8,000. The seller agrees to pay them, but you have to increase the sales price to $158,000. As long as the home appraises for at least $158,000, you should be okay. This means that your monthly payment is now a little higher and you pay interest on the $8,000 that the seller will give you at the closing. The seller walks away with the same amount of money whether he helped you with the closing costs or not.

Who Can Help You With the Down Payment?

What if you truly cannot come up with the down payment? Who can help you? While it’s not the seller – anyone that isn’t involved in the transaction, such as the real estate agent, can help you. Typically, this means family members. They can give you gift money, but this gift money is different than the gifts you receive on your birthday.

Lenders need to trace the origination of the gift money. In other words, they need to make sure that it’s not a loan somewhere down the road. They will need a gift letter from the donor, stating that the money is a gift, the purpose of the gift, and that it doesn’t need to be repaid. The donor must include your name and the address the money is meant to help purchase. The donor must then sign and date the letter.

The donor will also have to provide proof of the funds’ origination. Typically, lenders require only 2 months of bank statements to show that the donor has possession of the money. If there are any large deposits that don’t coincide with the donor’s income, the lender may need further proof of the funds’ origination to make sure there isn’t a loan hidden down the line somewhere.

The bottom line is that the seller can help you, but not with the down payment. If you need help with your down payment, you’ll need either a no down payment loan program, such as the VA or USDA loan, or you’ll need to receive the funds as a gift from a family member.

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How Much do You Really Need to Buy a House?

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You know you want to buy a house, congratulations! Now comes the hard part – saving money for the house. You know there are different loan programs out there, so just how much money do you need?

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We will help you understand the different requirements below.

Difference Between the Down Payment and Closing Costs

First, know that the down payment isn’t the only thing you need to think about when buying a house. You also have to pay closing costs. These are separate from the down payment. The closing costs can add up to as much as 3% – 5% of the loan amount.

Here’s an example. If you plan to put down 20% on a $200,000 home, you would need $40,000 just for the down payment. You would then need between an additional $6,000 to $10,000 for the closing costs. This means anywhere from $46,000 to $50,000 to close on the loan.

Do You Need a 20% Down Payment?

Now here’s the real kicker – you don’t need a 20% down payment. Many people believe this is the only way to get a loan, but it’s not. You can put down as little as 3.5% in some cases. In fact, some loans even allow you to get away with no down payment; you just pay the closing costs! So how do you know how much you need? It depends on the type of loan program you choose.

Conventional Loans

Conventional loans carry the stigma that you need a 20% down payment, but that’s not the case. Yes, you need 20% down if you don’t want to pay Private Mortgage Insurance, but you can still get conventional financing without that large down payment.

You’ll find conventional lenders that allow you to put down as little as 5% on the loan. This does mean you will have to pay PMI until you owe less than 80% of the home’s value, but it gives you the chance to get conventional financing with its low-interest rates and attractive terms.

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FHA Loans

If you don’t qualify for conventional financing because your credit score is too low or your debt ratio is too high, you may want to consider an FHA loan. With FHA loans, you only need a 3.5% down payment. The FHA allows lenders to provide you with 97.5% financing.

In exchange for the large loan amount, you’ll pay an upfront mortgage insurance fee as well as an annual mortgage insurance fee. The annual MIP is added to your mortgage payment each month. You pay 1/12th of the annual amount each month. FHA loans don’t offer the option to eliminate MIP after you owe less than 80% of the home’s value, though. You pay the MIP for the life of the loan, so keep that in mind.

VA Loans

If you are a veteran of the military, Reserves, or National Guard, you may not need a down payment on your home. If you are eligible for VA financing and qualify, you can borrow 100% of the home’s purchase price. VA loans only charge an upfront funding fee in exchange for offering this loan to you; they don’t make you pay for mortgage insurance.

It’s important to remember that even with a 0% down payment loan, like the VA loan, you’ll still need the money to pay the closing costs. Lenders will verify these funds just as they would if you were to put money down on the home.

USDA Loans

USDA loans are another government loan program that provides 100% financing on your home. The catch with USDA loans is that you must be a low to middle-income family in order to qualify. You also must buy a home in a ‘rural’ area. The USDA has loose guidelines regarding what is rural, so you may be surprised to find the areas that you can live and still get 100% financing. USDA loans do charge upfront and annual mortgage insurance, though, just like FHA loans do.

So how much money you should save to buy a house depends on your situation. Obviously, the more you save, the lower your mortgage payment will be. It’s also the less interest you will pay over the life of the loan. If you don’t have money to put down on the home and cover the closing costs, you may want to consider a government-backed loan, such as the USDA or FHA loan to help keep your costs down as low as possible.

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What are the Down Payment Gift Tax Consequences?

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The down payment is often the hardest part of the home buying process. It’s often the reason people continue to rent, rather than buy a property, because they don’t have enough money to put down on the home.

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Fortunately, many programs allow the use of gift funds. In other words, a family member, close friend, or employer may gift you money to put down on your home. Many people wonder about the tax implications of doing this. Does it affect you, the donor, or neither?

Accepting Gift Funds

As the recipient of gift funds, you’re off the hook when it comes to the IRS. They don’t tax the money because the donor already paid taxes on it. The money is a gift, not money you earned for doing something.

Of course, this must be documented so that the IRS knows it is a gift. Fortunately, lenders require this too. The donor must write a letter that states the money is a gift, the reason for the gift, and the amount provided. As long as the donor puts a statement in the letter that this money is a gift, you don’t have to worry about the taxes on your end.

Giving the Gift Funds

The donor may or may not have tax implications for giving you money. It depends on the circumstances. The important thing to know is that the donor probably won’t have to pay taxes this year or the year they gift you the money. Here’s why.

Each person has a lifetime amount they can gift without tax implications. That lifetime cap is $11.4 million right now. Remember, this is over an entire lifetime. On top of the lifetime cap, each person has a $15,000 exclusion per person. What this means is that the first $15,000 that you gift to any one person won’t count toward your lifetime cap and you won’t have to worry about paying taxes on it.

Here’s an example:

Your dad agrees to help you with your down payment. He offers to give you $15,000. The lender approves it, so you accept it. Your dad doesn’t have to pay any taxes on the gift he gave you and it doesn’t decrease his lifetime cap because it’s not over $15,000.

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Now if your dad gave you $25,000 for your down payment it would look a little different. Since the $25,000 is more than $15,000, the $10,000 difference would count against his lifetime cap. Now obviously he still has a long way to go before he meets the cap, but it’s worth knowing that it decreases the cap.

Married Couples and Gifts

The maximum gift limit applies separately to married couples. In other words, the gift must be in one spouse’s name or the other – not both. This can work to your advantage. You can split the gifts if the total amount puts either of you over the $15,000 limit. For example, a $30,000 gift could be $15,000 from your dad and $15,000 from your mom. This keeps them exempt from the taxation while staying within the law.

Filing Taxes as a Donor

Keep in mind that even if a donor doesn’t owe taxes for gift funds, he or she may still have to file the proper tax forms. Donors must complete IRS Form 709 – US Gift Tax Return. The form must be completed in order to keep track of the gifts provided that affects your lifetime maximum. You must file the return with your standard 1040 by April 15 (October 15 if you extend).

Handling Gift Funds with Your Lender

Aside from the tax implications, you as the recipient must know what your lender requires. Don’t accept gift funds without first talking to your lender. Find out what they need in regards to proof of the gift. A gift letter is a given – all loan programs require that, but what else do they need? Many lenders require a paper trail, ensuring the money belongs to the donor and isn’t a loan somewhere down the line that affects your debt ratio and your mortgage eligibility.

Lenders will tell you how to handle the disbursement of funds and what proof they need that the transaction took place. Working closely with your lender and your donor’s tax advisor will have the best outcome. Everyone will come out of the process with the end goal met – helping you to buy a home.

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Understanding Seasoned Funds

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Did you know that when you take out a mortgage, you can’t just use any money that you come across for your down payment or closing costs? Lenders want what’s called ‘seasoned funds.’ Just what does this mean and how does it affect you?

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Keep reading to find out.

What are Seasoned Funds?

Seasoned funds, in the eyes of the lender, are funds that have been in your bank account for at least 60 days. They are seasoned because they have been in your account for at least two months. That’s plenty of time for any loans, such as a second mortgage or a personal loan, to pop up on your credit report. Lenders can then put two and two together, figuring out that you borrowed the money for the down payment.

If the money sits in your account for at least 60 days and there aren’t any new loans on your credit report within that time, the money is considered sourced. The lender won’t ask for proof of origination. Instead, they consider it your money and you are free to use it for the down payment, closing costs, or qualifying purposes.

Why can’t you Just Add Money to Your Account?

It seems silly that you just can’t add money to your account, right? It’s your money after all. But, lenders need to protect themselves against default. They need to know that the money in your account belongs to you and you are free to spend it without the worry of repayment.

Even in situations, such as receiving a bonus from work, getting a tax refund, or receiving money for your wedding must be sourced or you must wait until the funds are in your account for at least 60 days. Fortunately, it’s easy to source money from most situations, such as:

  • Selling property
  • Selling a car
  • Selling stocks or bonds
  • A bonus from work
  • A tax refund

If you can provide proof of the funds, you can use them even when they aren’t yet seasoned. If you can’t provide proof of origination, wait at least 60 days or you risk loan denial.

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Lenders need to protect themselves. They need to know that you can easily make the mortgage payment. If you can’t source the money, they assume one of two things:

  • You borrowed the funds and must pay them back
  • You are just using the funds to inflate your account to get qualified

Obviously, inflating your account doesn’t work. You need the money for the actual down payment and closing costs. Borrowing funds affect your debt ratio and your ability to repay the mortgage, which could lead to a loan denial.

What Funds Don’t Need to be Seasoned?

While it all sounds complicated, there are some funds that you don’t have to worry about seasoning:

  • Automatic deductions – If you have a portion of your paycheck deducted every pay period and placed in a savings account, lenders can see the pattern. You don’t have to wait until all the money is in there for 60 days. The proof from the last several paychecks will be plenty to prove your intentions.
  • Retirement accounts – If you are a first-time homebuyer or you are of retirement age, you may take funds from your retirement account. Providing your retirement statement and your deposit ticket is plenty to prove where the funds came from. You don’t have to wait until you have the funds in hand for 60 days.
  • Gift funds – Family, close friends, employers, and charitable organizations may provide you with gift funds. This is money they give you rather than loan you. With proper documentation, you don’t have to worry about seasoning these funds.

Most loan programs allow the use of at least some gift funds. In order to accept them, seasoning or not, you need a gift letter and proof of the funds’ transfer. The gift letter must include:

  • Name and identifying information for the donor
  • Relationship between you and the donor
  • Amount of the gift
  • Reason for the gift including the property address
  • A statement that the money isn’t a loan and no repayment is expected
  • Date of the gift

Lenders use the gift letter along with proof of the deposit on your end to accept gift funds. If they are worried about where the funds came from, they may ask the donor for proof of funds’ origination. Providing the last two months of bank statements, investment statements, or the bill of sale of an asset will suffice.

If you are unsure about whether your funds are seasoned or not, talk to your loan officer. As a general rule, if the funds are in your account for 60 days, you’re good. Of course, every lender has its own rules. Some may still require proof of the funds’ origination if it’s an extra-large deposit. Carefully evaluate your steps before applying for a mortgage for the best results.

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