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Basics and Importance of Down Payment

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A down payment is the amount of cash deposited towards the purchase of a property, whether residential or business property. The down payment is not included in the loan amount. The larger the down payment, the lesser is the loan amount required to finance the purchase of the property. Down payment refers to the difference in the sales price of the property and the loan amount.

For example, suppose the value of a property is $400,000. Martin is interested in purchasing that property. So, he gave $100,000 in cash to the seller and obtained a mortgage loan for the remaining amount which is $300,000. Here, $100,000 is known as the down payment.

Generally, lenders require a down payment of 10% to 20% to be paid by borrowers at the time of closing. There are also lenders who accept 3% to 5% of the sales price towards the down payment. Some lenders also offer low down payment or zero down payment loans. But down payments less than 20% of the sales price often require you to purchase private mortgage insurance policy. Borrowers under this policy are required to pay for private mortgage insurance premiums until they have paid back 80% of their property value. The private mortgage insurance policy helps lenders overcome financial loss in their mortgage if the borrower fails to make mortgage payments in time.

A down payment of about 20% helps you to avail loans at lower interest rates than with down payments of 5% or less. Therefore, you end up paying lower interest throughout the loan term, especially in case of long term fixed rate mortgages. This helps you to save a large fraction of your income. Moreover, when you pay a down payment of 25% or even more, you may easily get the loan amount without the lender willing to check your past credit problems and present income.

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The down payment often includes funds from a number of sources that can be your Individual Retirement Account (IRA), your 401(k) account as well as gift assistance from your relatives, friends and employer. There are several loan programs that accept gift assistance programs. Some of the sources that can help to acquire gift funds are given below:

    Withdraw money from IRA
    If you are a first time buyer, then under the laws set up by Internal Revenue Service, you can withdraw funds up to $10,000 from your retirement account to finance your down payment. If you have a spouse, then each of you can take out $10,000 from your retirement accounts. It is easy to qualify for such facility provided you did not own a principal residence during 2 years before the purchase of the present property. In such cases, you may not have to pay a penalty for early withdrawal but whether you have to pay taxes on the money borrowed, depends on the type of IRA.
    Borrow from 401(k) Plan account
    You can borrow cash from your 401(k) Plan account to make your down payment. But unlike an IRA, a 401(k) Plan account requires you to pay back the money borrowed along with the required interest. The amount repaid will be slightly higher than the amount borrowed since you have withdrawn pretax money but will be paying it back with taxes charged on the amount withdrawn.
    Gift assistance
    There are loan programs like the FHA (Federal Housing Administration) loans that allow borrowers to accept gift funds from relatives, friends or even your employer, the church or any non-profit organization. But the lender in this case requires you to submit a gift letter from the source as a proof of the gift funds. The best thing about this is that you need not pay back the cash provided as gift money.
    Assistance from Government, state agencies and non-profit companies:
    There are several local and state agencies which conduct bond programs that provide borrowers with cash required for making down payments. Most agencies have purchase limits for which one can qualify provided he has the required income level.

There are also several non-profit organizations that provide down payment assistance to home owners. The gift amount is equal to 3% of the sales price or it can even extend to about $22,500 in some cases. These assistance programs require borrowers to qualify for any loan program with a particular lender. Buyers can receive free gift allowance through these programs. However, there are other gift assistance programs which require a buyer to undergo a Home Ownership Counseling Course or contribute 1% of their own funds towards the down payment. The amount of gift funds depends on the income and assets of the borrower or whatever amount of reserves are there in the bank. These programs are available with FHA, conforming as well as jumbo loans and they are offered against properties that include Single family (1-4 unit) homes, condominiums, manufactured/modular homes, properties under construction etc.

However, if paying for the down payments becomes a problem, you can apply for low down payment or zero down payment loan programs. Government sponsored agencies like Fannie Mae offers 3% down payment for long term fixed rate mortgages. Even the FHA provides low down payment loans that require 3% to 5% of the sales price as the down payment. The FHA even offers 100% gift funds towards the down payment. The Department of Veteran Affairs offers zero down payment loans but it requires that you to be a qualified veteran.



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