It's difficult to save enough cash to buy a home. The most common
reason stated by renters for not owning a home is lack of enough cash for the down
payment, closing costs, prepaids and reserves. However, there are many strategies to
minimize the cash you need to buy a home. It is possible to buy with only the down
payment and wrap closing costs and prepaid expenses into the transaction in various
ways.
The first step to minimizing the cash needed to purchase is to get
a good grasp on exactly what the costs will be. It is very helpful to obtain a Good
Faith Estimate from a lender to verify these numbers. A lender will be happy to provide
an estimate if you pre-qualify for a loan. Figure out how much money you would need
if you were going to pay all the costs yourself, then you'll know what you have to
cover.
The first place to start cutting your cash requirements is with the
lender. Take a zero point interest rate. That means the lender charges you a slightly
higher interest rate, but no discount points or origination fee. With today's low
interest rate environment, a zero point loan is still a fairly low rate.
The second place to find cash is with the seller. It is easy to
negotiate for the seller to pay your closing costs. The seller is interested in what
they will net from the transaction. Let's say the house is on the market for $180,000.
You think the seller would take $175,000. You need $3,000 to cover your closing costs
and prepaid expenses. So, offer the seller $178,000 with a $3,000 credit toward your
closing costs and prepaids. The seller nets his $175,000 and pays your costs.
Need to cover more? Let's look at that interest rate again. Let's
say that today's rates are 7% with 2 points or 7.75% at zero points. Some lenders
can offer an even higher rate and actually give you cash back toward your closing
costs or prepaids. For instance, in the above scenario, you can get 7.75% for zero
points, but if you will pay 8.75%, the lender will credit you with 1.75 points toward
your costs. These types of loans are called "overpar" or "no closing cost loans."
Even though you pay a higher interest rate, that interest is deductible and, in
today's interest rate environment, even an "overpar" rate is still low. The difference
in your monthly payment will be very small, but the difference in cash needed is
significant.
Your bank account is the first place you should look for down payment money. It is
easy to cash out, and it doesn't earn much interest relative to borrowing rates.
Most investment accounts are easy to liquidate, but you may want to hold on to your
bonds and employee stock options until they mature.
Many retirement accounts allow you to borrow against them when you are buying a house.
However, this increases your debt and therefore lowers the amount you can borrow to
buy your new home.
If you have sold (or plan to sell) your house, investment property or vacation home
and plan to use the proceeds for a down payment, don't forget to subtract transaction
costs and the amount that you still owe to lenders and the IRS.
When lenders look at the proceeds created by the sale of a property, they usually
take 10% off for transaction costs. So, if you sold a $100,000 house, they would only
count it as a $90,000 asset.
This accounts for a range of fees including the standard 6% real
estate sales agent fee. If you sold it yourself, they'll deduct less.
To determine your outstanding balance subtract all transaction costs and any outstanding
mortgage payments from the gross proceeds of your sale (gross proceeds - transaction
costs - outstanding mortgage payments = outstanding balance). Note: don't forget
those any prepayment penalties if you bought the house recently.
If you're not sure, check your mortgage agreement to see if you
opted for a prepayment penalty. If so, it is usually in effect for 3 years after
the purchase.
In August 1997, the federal government made major changes in the way the profits
from the sale of homes are taxed. To determine the tax on the profit from the sale
of a house sold after May 7th 1997, you need to calculate the profit and know how
much of the profit is tax exempt.
Real estate is one of the least liquid assets, but most people can't afford to own
two houses at one time. Regardless of whether it is a savings account, checking
account, or money market account, lenders see bank accounts as highly liquid assets.
Money hidden under your mattress and recent large deposits can only be used for a
down payment if you can document where you got the money.
If the deposit is a family gift intended for the down payment,
be sure to get a "Gift Letter" documenting it.
The lender's fear is that this large sum of money that magically
appeared came from a borrowed source. If the house is purchased with borrowed money,
that would raise your debt ratios and means that, effectively, none of your own
money would be in the transaction. The lender is also concerned with whether the
new money is illegal money, because if so, the government can take the house and
the lender is out of luck. Most lenders are insured against such things, but they
still want to avoid laundering money.
If you have a joint account with your spouse, you can count the entire balance as
an asset. A joint account with any other person, even if they are buying the house
with you, can only be counted as an asset if you get a letter stating that you have
access to the full amount from the other holder of the account.
If you close a certificate of deposit account (CD) before it matures, you will be
charged a penalty. Often, this will mean that any accrued interest will be lost.
This is not the end of the world if you just opened the account,
but if it's two months from maturity, you might want to reconsider cashing it in.
If you decide to cash in your investments, be realistic about how much cash they
will generate for your down payment. This means making conservative assumptions
about the performance of your portfolio and taking into account the cost to cash it in.
Stock options usually have a low initial value and have the potential to be worth
quite a bit more in the future. This can make selling them a last resort.
With a savings bond, early redemption will cause you to lose some accumulated interest.
You need to make sure that cashing in a savings bond would significantly change your
down payment amount enough to make it worthwhile.
A treasury note is not liquid. If it hasn't matured, you can't use
it. A mature note can be used, but make sure that you don't renew the note before
you try to sell it.
If you have any savings bonds or treasury notes that you would
consider selling for the down payment, count their redemption value.
Lenders know that by increasing your debt you have less money each month to pay
your mortgage. So if you would prefer to borrow against your investments rather
than selling them, remember that the added debt lowers the size of the mortgage
that you can qualify for.
With a 401k, you can usually use 100% of your personal contribution and about 50%
of your employer's contribution for a down payment.
There are two basic ways to draw on your 401k:
If you choose to do this, be aware that you have to pay a tax penalty, and that
your participation in your company's 401k program may be suspended for as much
as 1 year. Given this penalty, this is generally not a good idea.
You can use your 401k as collateral for a loan to buy a house. This loan can
only be for up to 50% of the vested amount in your account. Usually, you can
only take out one loan on your account at a time, so if you are planning to
borrow against it for your kids' college tuition or need the security of having
that money around in case of an emergency, don't use it now.
Also, know that if you change jobs and don't roll over the
account, you may have to pay the loan back immediately, or it will be counted
as a withdrawal and will be taxed.
Remember that if you borrow against your 401k, you will have
to make payments on the loan, which decreases the amount cash that you have
available for your mortgage payment.
IRA accounts can be a little more complicated than 401k accounts. Many allow
you to withdraw up to $10,000 to buy a first home, but it's often only after
you have held the account for a few years.
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