Mortgage 101

Can You Borrow Money for a Down Payment?

By Arlene Isenburg on June, 16 2021
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Arlene Isenburg

The down payment is often the biggest obstacle to homeownership. Saving enough money can take months or years, keeping you renting even longer. It’s a vicious cycle. How do you save when you’re throwing away money on rent every month? 

Conventional wisdom says you should put down 20% on your home to avoid paying for Private Mortgage Insurance (PMI) and higher closing costs. But conventional wisdom doesn’t pay your bills. In fact, the average first-time buyer puts down 6%. You should put down whatever is right for your situation. But should you need help with your down payment and closing costs, there are options. 

Borrow from Retirement Funds

Borrowing from your 401(k) or Roth IRA is a valid option. You can borrow up to $50,000 and $10,000, respectively. But borrowing from your future has consequences. In addition to taking money from your retirement savings, you could face taxes/penalties, so get informed and talk to your financial advisor before taking this step. If you lose or leave your job, you will have to pay the 401(k) loan back or pay a penalty.

Get a Piggyback Loan

Also called an 80-10-10 loan, this lets you put less than 20% down while avoiding PMI. With a piggyback loan, you would have two loans--typically, a mortgage for 80% of the price of the house and a second loan/line of credit for 10% that piggybacks on the first loan. That leaves 10% that you would be responsible for as the down payment. There are piggyback loans where you put down even less, but they are rare. Of course, there are tradeoffs. Piggyback loans tend to have higher interest rates that can increase over the life of the loan, and they may complicate a future refinance. 

Borrow Against the Equity in Another Property

With this low-cost possibility, you can use your equity in an existing house to help you buy a second. But, of course, you need to have another property for this to even be an option. A lump-sum home equity loan is the most popular way to fund a down payment, but there are also home equity lines of credit and cash-out refinances.

Seller Financing aka Seller Carry

Though uncommon (with less than 10% of sellers offering it), this is a kind of piggyback loan in which the seller carries the second loan instead of the buyer. With the seller as the “lender,” the loan is often shorter-term, has smaller monthly payments, and has a balloon payment with the entire balance due several years after closing. Real estate laws lay the groundwork for these deals, including requiring interest rates to be fixed for five years and increase no more than 2% a year afterward.

Help From Friends or Family 

Many lenders allow gift money to be used for at least part of the down payment, but you must provide documentation showing that it was a gift and not a loan. If you have family or friends generous enough to help with your down payment, this may be the best financial option. But lenders may take gift funds into account when deciding to give you a loan.

Personal Loan

Generally, lenders don’t allow personal loans to be used for a down payment, though there are rare exceptions. And there is a point in time when borrowed money is no longer considered borrowed and becomes yours. That point is typically 60 days, depending on the lender when the money is considered “seasoned.”

However, a sudden windfall could make your lender suspicious and put your mortgage in jeopardy. Remember, down payments lessen the risk to the lender and prove to them that you are financially stable enough to afford their loan. So they may not like the idea of a borrower paying off their loan with another loan. Having a personal loan may make it harder to get a mortgage and may mean a higher interest rate.

Find the Right Loan for You

Down payment loan options are limited and have drawbacks. Your better option may be finding a loan that doesn’t require a big down payment. Before borrowing money for a down payment, look into all the loans available to you. Remember, a 20% down payment isn’t required, and the type of loan you get can inform how much you put down. If a large down payment would be detrimental to your long-term finances, there are alternatives. Here are the most common loans that allow for low and no down payments:

FHA Loans

Considered to be the friendliest loan for first-time buyers, FHA (Federal Housing Administration) loans require only 3.5% down. Backed by the Federal Department of Housing and Urban Development (HUD), these loans are offered by traditional lenders and allow below-average credit scores. PMI is required.

USDA Loans

Available only for homes in rural and less populated areas, USDA loans do not require a down payment at all. Backed by the U.S. Department of Agriculture, these loans also have an income limit--115% of the local median income. But like FHA loans, borrowers must pay PMI. 

VA Loans

Available only to members/veterans of the military, VA loans have no down payment requirement. Borrowers can put down 0% and don’t have to pay for PMI, but they do have to pay a one-time “guarantee fee.”

The Conventional 97 Loan

Available to borrowers with a credit score of at least 620, this loan requires a 3% down payment. Backed by Freddie Mac and Fannie Mae, it allows buyers to pay for the entire down payment with gift funds.

HomeReady and Home Possible Mortgages

Designed for low-income and multi-generational families (but available to everyone), these loans require a 3% down payment. These conventional loan programs are backed by Fannie Mae and Freddie Mac, respectively, and may require borrowers to enroll in an educational course. Buyers with these loans get mortgage rate discounts and are allowed to use the incomes of multiple residents to meet the lender’s income requirements.

Down Payment Assistance Programs

In addition to the special loans above, there are over 2,500 Down Payment Assistance Programs nationwide that help lower-income and/or first-time buyers. Offered by nonprofits, state/local governments, and even employers, buyers can get low-interest/no-interest loans for down payments and closing costs. There are also grants and loans that don’t have to be paid back, or at least not if you live in the home for a certain amount of time or meet other requirements. 

Final Thoughts

There are options to borrow money for a down payment, but they may not be ideal. Be sure to consider all the ramifications before getting a loan on top of your loan.