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Ideas for Solving the 20% House Downpayment Dilemma

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I asked a few friends of mine why they didn’t maximize the contributions to their 401(k) each year and the number one reason was that they were saving up money for a downpayment on a home. All of my friends are young professionals with good salaries but with your typical rowhouse in the area costing around $200,000 to $350,000, with many far more, it’s extremely difficult for someone to come up with the $40,000 to $70,000 required for 20% down. What’s adding to the difficulty is that it doesn’t even consider the closing costs which can get up to $10,000. So, what are some strategies you can use to come up with the 20%?

First, How Much Will You Need?

This is step one, calculating how much you’ll need to save in order to reach your goal of a 20% downpayment. After you have this target number, you can start employing the strategies below to figure out how you’ll get there. Let’s say you want to buy $300,000 of house in 2 years, so that means you have 24 months to save up the $60,000 downpayment. I think you can use a conservative estimate of 4% for the appreciation of your money in savings (let’s ignore inflation because the estimates for inflation and its effects over two years are too variable to use historical numbers).

Now, calculate how much you’ll need to save over 24 months to reach $60,000. Here’s a savings calculator (you will need Java installed, but it should ask if you don’t have it) that you can play with to reach your answer (I used a business calculator). Enter in $60k for the savings goal, 2 for the years to save, and all the other pertinent data. If the graphs aren’t updated, click on the Calculate button. The answer is $2,375 (the white boxes). You can enter in your current savings to see how far away you are, but $2,375 is your target number each month if you want $60k in 2 years at 5% appreciation. So, how do you get there?

Find A Smaller House, Different Location

Now that you have the target number, it’s time to play with it. While this sounds like a no-brainer, it isn’t that clear when you’re searching around for homes that you should settle for less house. What used to be a “starter home” in an area ten years ago is no longer a starter home as home prices, even after the recent slipping, have vastly outpaced inflation and wages. In your mind’s eye you have an image of what you’re first home was going to be, I know I had an image of a first home that looked like the home I grew up in (my parents still live there and have done so for the last 27 years). The problem was that home is at least half a million dollars in the nicer areas of Maryland, if not more depending on the home’s age and specific location, so it wasn’t within reach.

Next step? Think townhouse. Single family home on my salary was an impossibility unless I was willing to sacrifice other factors such as the location, which I wasn’t, so a townhouse was my next option. If you’re a handyman or handywoman, consider getting a fixer-upper. If you’re not picky about the location, pick a less desirable location. Ultimately the first step is finding out how little you’re willing to pay for a home and how much you’d be willing to pay and check out your options.

So, let’s say you are now willing to live in $200k worth of house and thus need only $40k in a downpayment in two years. $1,583 is now your target savings per month, a difference of $792 each month.

Ask Your Parents (Relatives, Grandparents, Etc)

This is how I was able to come up with any type of downpayment (I was only about to get around 10%, even with my parent’s help) and it’s something that requires a little of preplanning because of gift taxes. The donor must pay gift tax on any gift over $12,000 in 2007, so if your parents can help then it will help their tax situation to spread the gift out over the years. If you do this, keep this sample gift letter template in your back pocket because you’ll need to send a version to your lender when you request a mortgage.

Let’s say you’re back to a $300,000 house and your parents (or benefactor) gives you $10k right now. Enter that as your “Amount currently saved” in the tool and you’ll find that your magic number per month has fallen from $2,375 to $1,939, or a difference of $436 of savings each month.

Cut Back On Retirement Savings

This is another option that I and many of my friends did to help save a little extra. I still put in my maximum Roth IRA contribution and the minimum needed to get the employer match for my 401(k), but I didn’t contribute any more to retirement outside of what I consider the bare minimum. Some might not even contribute to a Roth IRA, but I would consider that a mistake. At this point you’ve stopped reducing the magic number and started focusing on increasing your savings, so it doesn’t make much sense to look at the calculator anymore.

Cut Back On Discretionary Spending

Start finding trimmables in your budget so you can get your savings up to your target savings rate to achieve your goal. The trimmables post I wrote back in October of 2005 still applies today and it was motivated by my own savings plan when I bought a house. It’s easy to cut something back when you think it’s only temporary and when you have a goal in mind.

I hope that with a little bit of math and some suggestions I’ve been able help some prospective homebuyers wrap their heads around where they can look to get that 20% downpayment, it was the approach I took and it ended up working for me so I hope it works for you. If you have any suggestions or ideas that I’ve missed, please let me know and I’ll add them to the list. I hope that this helps people understand that while getting 20% is difficult, it’s not impossible if you’re diligent.

{ 25 comments, please add your thoughts now! }

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25 Responses to “Ideas for Solving the 20% House Downpayment Dilemma”

  1. Bob says:

    As I understand gift tax policy, the $12,000 you cite is a maximum a single person can give, not a maximum amount a single person can receive. That said, parents + grandparents could hypothically give $24,000 to anyone of there graindchildren in a given year.

    So…if you’re fortunate enought to have parents and grandparents (two sets?) that are living and able to donate, you could possibly get $72,000 ($24k x 3) gifted to you in one year with you nor anyone in your family obligated to report the gift or pay taxes on it. I realize that’s highly unlikely for most people, but for illustrative purposes…

    From http://www.irs.gov/pub/irs-pdf/p950.pdf

    Annual exclusion. A separate annual exclusion applies
    to each person to whom you make a gift. In 1998,
    the gift tax annual exclusion became subject to
    cost-of-living increases. The exclusion for 1998 through
    2001 was $10,000 and for 2002 through 2005 the exclusion
    was $11,000. For 2006 and 2007 the amount is
    $12,000. Thus, in 2007, you generally can give up to
    $12,000 each to any number of people in 2007 and none
    of the gifts will be taxable.

    If you are married, both you and your spouse can
    separately give up to $12,000 to the same person in 2007
    without making a taxable gift. If one of you gives more
    than $12,000 to a person in 2007, see Gift Splitting, later.

  2. Patrick says:

    My parents used a loan from their parents to afford the down payment for their first house. It is a good option if your parents are able to help out. My parents bought their house well over 20 years ago though, when you pretty much needed 20% down to get a home loan. Nowadays, too many lenders are allowing home buyers to take out piggy-back loans, ARMs, or other exotic mortgages that the buyer probably can’t afford. Most people would do better to follow your tips in this article.

    One other option: Many military members and veterans are eligible for the VA Home Loan. With the VA home loan, home buyers are not required to put down 20% to buy a house, however, the monthly payments will be higher because the buyer is financing more.

  3. jim says:

    Bob, you’re right, I’m sorry for not being clearer in the original article. Thanks for clearing that up and providing the IRS section about it.

    Patrick – The problem with using a loan from somewhere else is that it has to be declared as such when you talk to your lender. They need to know the total amount of debt you’re carrying before they quote you a rate, by saying it’s a “gift,” you can get a lower rate.

  4. Jeff says:

    I am currently saving up for a down payment, and I just reduced my retirement plan contributions. I’ve also cut most of my discretionary spending. Getting the monthly cost of homeownership down will greatly increase my ability to contribute to my retirement plan in the future.

  5. Blaine Moore says:

    My wife and I put down a 16% down payment and took out two mortgages (one for $12,000 at 7 1/8 and one for 80% at 6.25) that let us avoid PMI. My wife had money saved up, and technically we had enough for a full 20% down payment, but we wanted to keep an emergency cushion since she was only planning on working for another 5 months after we bought the house.

    Since then, we’ve been living off of my income without too much trouble.

  6. Compounding says:

    Why deal with the 20% downpayment? Here are my thoughts. Figure out something reasonable for your first home. Then, add 20% to the expected payments, and subtract your current rent. Add this much to savings for an entire year. If you had no issues, buy a home and use those savings for a downpayment. Whatever you are short of for the 20%, just get a piggy back loan, and have an accelerated payment plan for it.

    Really, waiting on a home is silly, if you can afford it. Each mortgage payment contributes to some principal payment, whereas rent is money lost. The sooner you can comfortably get into a house, the better.

  7. Rob Carlson says:

    Watch those gift notices carefully. Pretending that a loan for a house down payment was actually a gift was what ultimately got Ed Norris sent to federal prison.

  8. Miller says:

    As a potential home buyer, the burning question for me is whether or not you truly need that 20% these days. A long time ago? Yes. In the last 5 years? No. Well, with the air leaking out of the housing bubble, and the so called “credit crunch” (isn’t that a great name!), where do we stand? In fact, who would I get in touch with to answer that question anyway? A lender (obviously, I’m wet behind the ears here)?

  9. FatLady says:

    If avoiding PMI is the point, you can take out two mortgages: one for the amount remaining after the cash you can put in to come up to 20% and one for the remainder of the house’s cost. My son & I copurchased a house as an investment and as a place for him to live until real estate values head north again. We each put in some cash but it didn’t come up to 20%. So we ended up with one loan for $188,000 and another for $23,000. The larger is a 30-year fixed-rate loan; the smaller is paid at a fixed rate over 30 years but callable in 15 years.

    This scheme cuts out the PMI.

    Our plan is to pay off the small loan within three to five years, leaving us with substantially more than 20% equity in the house (we got it for $15,000 under appraisal, and property values have not dropped significantly since then) and a smaller loan payment for the duration of his residence in the house.

  10. It’s becoming a nightmare for first-time buyers here in the UK. With average house prices now around £200,000, FTB’ers are being asked to stump up £40,000 just to stand any chance of getting a mortgage, and with a possible credit crunch coming, they may even get refused a mortgage in the future as banks tighten their lending criteria.

    Where I live in Somerset, average house prices are around £210,000, but average salaries are around £20,000 with many people earning less than this so it’s no surprise that a lot of people are still living at home into their 30′s or borrowing huge sums from their parents to get them on the property ladder.

  11. bryan says:

    ive done the piggyback loan route. your second mortgage will have a much higher interest only rate (likely over 10%). simply pay this down faster and dont contribute any extra to the first loan.

    other options are lines of credit, citibank credit card balance transfers at 0% where the money is sent directly to your checking account, visiting a mortgage broker who can accomodate 10% down payment (again this will be at a higher interest rate and not the best option).

    you can also ask the seller to carry a 10 year note at 10% of the purchase price…

    be creative. just because the lender needs 20% down, doesnt mean it has to be YOUR 20%. just borrow the money from any other source that is willing to lend it at reasonable rates….

  12. saladdin says:

    To me the point of putting 20% down is having no PMI, financing less and getting a better loan rate then someone with a 80/20. All of those save you money over the long run and more importantly to me, I can sleep better at night. By doing a credit card transfer, ARM, 80/20 or borrowing from friends/family all you are doing is shifting the 20% around.

    Someone above said rent is lost. Which is not accurate to me. If I can rent for less then what a mortgage would cost and invest the difference for the time being how is that losing?

    I frequent many mortgage forums because I am saving for a house. From those I get that 80/20′s are getting harder to come by. They are no longer automatic.

    When did it become so bad to save for what you want instead of wanting it now, now, now? Hell with the consequences. Some reasons the housing market is bottoming out is because people thought that rent was wasting money and decided to do 100% LTV loans instead of saving 20% down. Look how that worked out.

    And personally, I would never accept a gift from parents, grandparents or friends. To me (I said to me) being an adult means taking care of yourself. Not depending on mommy.

    saladdin

  13. Tim says:

    the $12k gift is a per year limit, but someone can give more even within the one year based on the lifetime tax free limit. you’ll have to file a return on it, but remains tax free if you are under the $1million lifetime limit.

    another option is not to buy a house. another option is to extend your time frame for buying a house rather than reducing your retirement investments.

  14. CK says:

    You can also gift around the 12k gift limit by making a loan to someone and then forgiving 12k per year in the upcoming years.

  15. FatLady says:

    Coinvesting in a financial instrument (which is what a piece of real estate is) and splitting the proceeds after a reasonable period of time is “depending on mommy”? How, exactly? If you coinvested in a business arrangement with a partner who was not related to you, would that be “depending on [fill in the blank]?”

    Do we have a problem with women, or what?

  16. Robert says:

    Patrick also forgot to mention that because a VA loan is guaranteed, you don’t need to pay that pesky PMI either in addition to not requiring a down payment. The interest rate will typically be slightly higher, of course.

  17. saladdin says:

    Please re-read the post.

    If you have to get a gift from parents/grandparents/friends to afford 20% down then I consider that “depending on mommy.” As an adult taking gifts from parents should not be such a simple decision.

    The only people I have a problem with is those that are not very bright and have trouble understanding simple posts. Of course this is not directed to anyone specifically.

    saladdin

  18. Tim says:

    who really cares if you take a gift? so what if someone is willing to help you out? more power to you if you can get your parents/relatives/friends to pay the 20%. I’d love to be in that situation.

  19. saladdin says:

    I care Tim. I understand that opinion also Tim. I was speaking for myself in saying that as a 33 year old guy I could not sleep at night knowing I had to rely on someone else’s money to get by. There is a difference in needing help to eat vs the need to buy that condo that just came on the market and have not saved a cent for. I have refused this kind of help before and will so in the future if it ever comes up again. You can call it stupid, ego or pride. But I know I would never feel as if the house was truly mine.

    What if you sell the house? Do you give that 20% gift back or keep it?

    saladdin

  20. Evan says:

    I feel the need to clarify –

    Everyone gets a $2mil Coupon for estate tax purposes (i.e. you can pass $2mil on to the next generation with no tax liability). Uncle Sam allows you to pass $1mil of that on during your lifetime, WITHOUT TAX LIABILITY (provided you file the appropriate form – Form 706).

    As such, you could gift the entire amount of the house and still have no gift tax liability (which is currently at approximately 45%).

  21. Tim says:

    saladdin, depends on how you look at life i guess. if you really can’t sleep at night knowing someone gave you money to help buy a house, then oh well. to me, who really gives a flying whoop, even if you are 33 years old or 40 years old. I understand people want to do things on their own for whatever reasons, doesn’t make other people bad if they don’t. i have no qualms about it. it isn’t always about you, it’s sometimes about letting other people help you that want to do so. sometimes pride gets in the way. oh well, we’ll be living happily when our parents pay for our house.

  22. mbhunter says:

    Time is on people’s side if they’re waiting to buy. 20% will be a lot easier to make in a few years for the same house.

    If you’re having trouble making the 20%, save, but realize that prices are still way out of whack in many places.

  23. I know, first hand, how stressful it is to save for a home. Now is the time to buy, right? I am working with an online bank named FNBO Direct, (you can check out their website at http://www.fnbodirect.com) they are putting on a YouTube contest that is encouraging people to “Pay Yourself First” You should check out the web page (www.pyfchallenge.com).

    Your readers could earn an extra $5,000 for their down payment, and a spa vacation. All they have to do is create a one-minute video telling FNBO Direct what they’re saving for, and why they should be selected as one of the five challengers… Upload the video to the group page (http://www.youtube.com/group/pyfchallenge) by July 31 to win. Heck FNBO Direct is giving a $10 gift card just for submitting a video and $500 to the top 20 videos. So just by submitting a video you at least get something!

  24. VBB says:

    My son and his wife earn about 130,000. Have car notes, credit card bills and school loans…they rent, but want to purchase a home. They have only 6000.00 to put down on a 150,000 home….and they want to take advantage of the 8000.00 new homeowner tax credit? Jobs are not secure…both are business consultants. We advise them to wait and save the down payment/closing costs/moving costs/incidental costs. what would you advise?

  25. CT says:

    I want to purchase a home from a relative. I’m buying the house for less than it is appraised for, so there will be about 25% equity in the house. Do I still need a 20% CASH down payment?


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