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Ways to leap over the down-payment hurdle

Today is a frustrating time for renters who want to buy homes but who haven't saved much for down payments. Mortgage rates are on the rise, houses aren't getting cheaper and it seems like time is running out.

"It would take me at least another year or two to save another $10,000 to $15,000, and, frankly, I want to purchase a house before the costs are out of reach," e-mails a reader from Long Island, where the median house price rose more than 20 percent last year.

He has more options than he realizes. There are myriad ways to leap the down-payment hurdle. Some strategies are for people who have some money saved up somewhere, and other strategies are for people who are practically broke.

It has been a long time since home buyers were required to come up with 20 percent down. Some lenders will lend 100 percent of the purchase price or even 103 percent. More commonly, lenders underwrite mortgages with 3 percent or 5 percent down. The question becomes: How do you come up with that 3 to 5 percent?

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Dig into the nest egg?
You could tap your retirement savings, either borrowing from a 401(k) account or withdrawing money early from an Individual Retirement Account.

When you borrow from your 401(k), you repay the loan over five or more years, with interest. Most 401(k) plans will let you borrow up to $50,000 of your balance or 50 percent, whichever is less.

One problem with borrowing against your 401(k) is that you will have to repay the loan within 90 days of losing your job or quitting. That can make a layoff even more stressful, and can serve as a pair of golden handcuffs that chain you to your job, even if a better one comes along. If you can't repay the loan in time, you have to pay penalties and taxes on an early disbursement.

An advantage of borrowing against a 401(k) is that it doesn't count as debt when lenders assess your qualifications for a loan, says Ellen Bitton, president of Park Avenue Mortgage in New York City.

Withdrawing money from an IRA can be a good strategy for first-time home buyers You pay taxes on the disbursement, but a 10-percent early-withdrawal penalty is waived if you use the money to buy your first home. Some advisers warn against removing money from a retirement nest egg.

"But," says Bitton, "in the long run, you'll probably have more appreciation on the money invested in real estate." She pauses, then adds with a laugh, "And maybe not. There are no hard-and-fast rules."

Borrowing against retirement savings is fine for people who have money set aside for their golden years. But what about people who have virtually no money in the bank?

Gifts from family and friends
Some loan programs allow borrowers to use gift money to make down payments. Generally, the gifts have to come from family members, spouses or domestic partners, or nonprofits.

In fact, an entire industry of nonprofit organizations has sprung up to fill this need. Most of the time, the home's seller "donates" 3 percent of the home's sale price to the nonprofit, plus a fee. The nonprofit then gives the buyer that 3 percent at closing, with the money serving as the down payment. Almost all loans using this approach are insured by the Federal Housing Administration.

Jason and Rebecca Postlethwait are using such a program to buy a house in Baltimore. When their landlord notified them that the monthly rent on their townhouse was going from $900 a month to $1,100, they decided to go house-hunting, even though they had some past credit problems as a result of lost jobs, and even though they had little saved for a down payment.

"We said, 'There's got to be a program for us,'" Jason Postlethwait says.

Their real estate agent told them about the Home Solution program, in which the seller ultimately contributes 3 percent for the down payment. Their monthly house payment will be less than the $1,100 they would have spent to continue renting the townhouse.

Help for those who need it
Another down-payment option is to take advantage of programs run by nonprofits to help low- to moderate-income people buy their own homes. These programs are of all sizes and kinds. Some are run by community development corporations that fix up abandoned houses in blighted neighborhoods, then team up with lenders that offer low- or no-money-down loans to qualified buyers. Habitat for Humanity requires buyers to contribute "sweat equity" by working on their and other people's homes.

Most states have housing finance agencies that offer special loan programs for low- to moderate-income buyers. Fannie Mae, the biggest buyer of mortgages, offers loans through housing finance agencies that require down payments of as little as 1 percent or $500, whichever is less.

No-down and low-down
No- and low-down payment loans have the disadvantage of requiring costly mortgage insurance. You can avoid mortgage insurance by getting a "piggyback loan": a home equity loan that piggybacks on top of a primary mortgage.

For example, you could put 5 percent down, get a primary mortgage for 80 percent of the home's price, and a higher-interest home equity loan for 15 percent of the price.

This is what Joel and Kathleen Eden plan to do. They are buying a house in Cherry Hill, N.J., with a 5 percent down payment from the proceeds of the sale of a condominium they own. They are getting a 20-year home equity loan for 15 percent of the purchase price, and a 30-year mortgage for 80 percent of the price. They won't have to buy mortgage insurance. That suits Joel Eden fine. They are paying $40 a month in mortgage insurance on their condo, and it feels like wasted money.

Mortgage insurance "seemed like a painful thing to pay," Joel Eden says, because it protected the lender and not him.

The payments on the second mortgage roughly equal what would have been the cost of mortgage insurance, but the Edens can deduct the interest expense on their income taxes.

Piggyback loans have zoomed in popularity in the past few years and are "kind of normal nowadays," says Bitton of Park Avenue Mortgage.

Can you say 'susu'?
For something exotic, she throws out another option -- susu, a method of saving money that can be found in some African and Caribbean cultures.

A susu savings plan consists of a group of people who pool their money and distribute it among themselves periodically, one by one. For example, a dozen people might contribute $1,000 each into the pool every month for a year. In the first month, one person gets $12,000. The next month, the next person gets $12,000, and so on. At the end of the year, each person has contributed $12,000 and received $12,000.

"In a way, it's forced savings," Bitton says, because the susu system uses peer pressure to compel people to save.

-- Posted: March 15, 2004
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