How to Cover a Down Payment and Closing Costs

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When buying and financing a home, many Americans have good credit and strong income but have not managed to stash enough away to cover the many upfront costs of homeownership. Down payment and closing costs are two of the major barriers to homeownership. The good news is there are a handful of ways that these costs can be covered without solely relying on what already exists in your savings account. 

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What are the Costs?

Cash to close is the broad term that refers to the total out-of-pocket expense associated with a purchase mortgage transaction. It includes everything that you as a borrower will have to cover in order to obtain a mortgage and purchase a home. This number can be divided into two parts:

Closing costs

When buying a home for the first time, borrowers are often blindsided when they receive a breakdown of all the costs associated with the transfer of property. While some of these costs have to do with the mortgage, many do not. These costs are broken down in detail on the second page of the loan estimate (LE), which all mortgage lenders are required by law to provide before accepting deposits. This is what it looks like:

Closing Cost Details

Resource: https://www.consumerfinance.gov/owning-a-home/loan-estimate/

Many of these costs do not vary from lender to lender, while others will. The most important of these costs to consider is origination. Your interest rate is the long-term cost of your loan and the origination is the upfront cost. It is a highly variable expense over which your lender has control. 

When shopping for a mortgage, there is no use securing a low-interest rate if you have to pay an enormous origination charge in exchange. When comparing one loan against another, be sure to include this factor in your calculations.

Down Payments

We’re all familiar with the touted advertisements from our local car dealership: “Zero Down!” “Sign and Drive!” “No Credit, No Problem!” and a whole host of tantalizing loan options. What we may not realize is that these high-risk loan options are often not in our best interest. From a bank’s perspective, lending is a risk/reward calculation, meaning that the higher the risk associated with your loan, the more money you’ll be charged over the long term. 

A down payment is one of the biggest considerations lenders weigh-in that risk calculation. Your down payment as a borrower is your “skin in the game.” The larger down payment you make, the more you have to lose if you default on your loan. If you make a smaller down payment, however, lenders must make up for increased risk exposure by increasing the cost (interest rate/closing costs) of your loan over the long term.

The down payment is an investment. When you make a down payment, that money does not go to the lender, rather, it is converted into equity (ownership) in the home, car, etc. you’re purchasing. In other words, by investing more upfront, you will be able to secure better loan terms and save a lot of money in the long run without losing any money.

When you finance a home, the ideal downpayment is 20% of the value of the home. On a conventional mortgage, a 20% down payment will allow you to avoid paying private mortgage insurance (PMI), a monthly charge that can cost hundreds of dollars (on top of your interest rate).

Eight Ways to Cover your Cash to Close

1. Decrease your down payment. 

Decreasing your down payment has its drawbacks. You will almost always get worse loan terms, like a higher interest rate or saddled with PMI. 

If you’re an eligible veteran, a VA loan requires no down payment, you retain the same interest rate and you won’t need to pay mortgage insurance. For the rest of us, there are other low down payment options like USDA, FHA, and even some conventional options to consider.

FHA loans allow borrowers to obtain a down payment as low as 3.5%. This option is fantastic for borrowers who have credit issues in conjunction with marginal assets, as it allows for a low down payment and does not penalize (or reward) borrowers based on qualifications. The drawback is that they carry an expensive mortgage insurance premium (MIP) which does not fall off at any point. Because of this, borrowers without credit issues should seek conventional loan options if possible.

USDA loans, like FHA and VA loans, are insured by the government and allow for looser qualifications requirements. USDA loans incentivize home ownership in rural areas, and, for that purpose, they require no down payment for those who qualify. However, like FHA loans, they carry expensive mortgage insurance that does not fall off.

Conventional loans are secured by Fannie Mae and Freddie Mac, and they are the most common residential mortgages on the market. To avoid PMI you have to put 20% down, but there are conventional options that allow you to go as low as 3% and sometimes even 1% down. The benefit of these options is that mortgage insurance on conventional loans is much cheaper than that on FHA or USDA. In general, if you have good credit and a strong income, conventional loans are much cheaper than government options (besides VA, of course).

2. Decrease your closing costs

Decreasing your closing costs will make it easier to cover your cash to close; however, the methods for doing so are not always cut-and-dried. Most closing costs are third-party costs and cannot be adjusted by you or your lender. Even so, you might not have to pay them. 

A. Seller concessions

One of the best ways to cover closing costs is to have the seller pay for them. This usually takes some negotiation, but if you can find a home that’s been sitting on the market for a while, or if you make a strong enough offer, it’s possible to get the seller to agree to pay some (or perhaps all) of your closing costs. This is called a seller concession, and here is how they work:

Imagine you found a home that you really like and you think the seller will accept an offer of $175,000. At that price, you don’t have enough money to cover all of your closing costs. Instead of placing an offer at $175,000 you offer $180,000, but request that the seller cover $5,000 in closing costs in return. In the end, the seller receives the same $175,000, you get the keys to your new home and you effectively roll your closing costs into your mortgage.

Seller concessions are a great option but remember, they must be negotiated, not to mention the property will have to appraise at a higher price, which places another unknown in the process and is a time-waste risk. A second way to help cover your closing costs is to have your lender pay for them. 

B. Lender credits

Your lender will often be more than willing to cover some (or all) of your closing costs. The drawback is that you will have to accept a higher interest rate in exchange. This is called a lender credit and is quite common in the industry across all mortgage types. 

Is this better for you or your lender? The answer depends on how long you carry the mortgage. Usually, if you plan to sell or refinance between one and five years after purchase, it might be to your advantage to seek a lender credit. If interest rates are low, or if you’re purchasing your forever home, you’ll likely be better off trying for the lowest interest rate possible (perhaps even buying down), since it will cost you significantly less over the long term.

The other consideration when it comes to lender credits is that they will cause your debt-to-income ratio (DTI) to increase, which makes it harder to qualify. If this is a concern, there is one last way to help cover closing costs.

3. Shop for title services

Most closing costs are third-party costs that neither your or your lender have control over. 

Shopping for title services does not have the potential to decrease your out-of-pocket expenses nearly as much as lender credits or seller concessions, but if you happen to save yourself between $250 and $800, that can mean the difference between renting and homeownership.

4. Apply for down payment assistance

Rising homeownership rates are indicative of a strong economy and demonstrate a trend toward wider distribution of wealth. Local, state and federal governments constantly come up with initiatives to encourage homeownership. Numerous programs help people purchase homes, especially for those purchasing for the first time. 

If you’re not a first time homebuyer (FTHB), don’t fret. You’ll be surprised at how far-reaching the government’s definition of FTHB is. Even those who currently own and are moving can be considered FTHBs under the right circumstances.

5. Use your 401(k)

Another path to homeownership is through your 401(k). 

The government has put rules in place that allow you to borrow against retirement accounts without actually decreasing the balance, as long as you buy a home. This way, you can avoid any penalties for early withdrawal.

6. Borrow money 

For the record, there are a host of restrictions against borrowing money for your cash to close, but, like borrowing against your 401(k), there are many ways to do so legally. Borrowing someone else’s money for your down payment raises your mortgage risk significantly. In fact, the government has placed restrictions on this practice.

Generally speaking, borrowing against your existing assets such as 401(k), mortgaging another home, refinancing a car, pawning jewelry, etc. is acceptable, but if the money is borrowed money from someone else (family member, lender, friend, boss) lenders will commonly reject your mortgage application. 

How will lenders know whether you’ve borrowed funds for your cash to close? The first thing they’ll do is ask you. If everything checks out there, they’ll go the extra step of searching your last two months of asset statements for any large unverifiable deposits. 

7. Receive a gift

Most lenders/mortgage options do not permit borrowing money from family members. However, Uncle Sam allows certain family members to gift you cash to close funds. The only requirement is these family members must state and sign that the funds are not to be repaid. 

8. Seek alternative financing options

If owning a home is your dream but for one reason or another you cannot find a lender that will approve your loan application, there are alternatives. Some sellers consider financing the sale themselves. This is called a land contract and is quite common. 

Other sellers will entertain rent-to-own arrangements, where after demonstrating a track record of on-time rent payment, they may consider assisting with closing costs or special financing arrangements. 

Keep in mind that there is much less oversight into these sorts of transactions so be sure to seek qualified legal counsel before entering into them. 

Final Thoughts

The common adage “it takes money to make money” still rings true. Unless you are a veteran who purchases a home at 0% down, have negotiated the maximum in seller concessions, receive lender’s credits and get a great deal on your title policy all at the same time, chances are you will not bring $0 to close on a new home. 

A combination of the tactics above can significantly decrease your out-of-pocket costs and greatly increase your chances of homeownership. Remember that each of these tactics has its drawbacks, so be sure to calculate the numbers and fully understand how you might be adversely affected before adjusting the terms of your mortgage.

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Get the Best Mortgage Rate
Work with the best mortgage professionals in the space. Get started with your purchase or refinance quote in seconds.

Frequently Asked Questions

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1) Q: How do I get pre-approved?

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1) Q: How do I get pre-approved?
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First, you need to fill out an application and submit it to the lender of your choice. For the application you need 2 previous years of tax returns including your W-2’s, your pay stub for past month, 2 months worth of bank statements and the lender will run your credit report. Once the application is submitted and processed it takes anywhere from 2-7 days to be approved or denied. Check out our top lenders and lock in your rate today!

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2) Q: How much interest will I pay?

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2) Q: How much interest will I pay?
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Interest that you will pay is based on the interest rate that you received at the time of loan origination, how much you borrowed and the term of the loan. If you borrow $208,800 at 3.62% then over the course of a 30-year loan you will pay $133,793.14 in interest, assuming you make the monthly payment of $951.65. For a purchase mortgage rate get a quote here. If you are looking to refinance you can get started quickly here.

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3) Q: How much should I save for a down payment?

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3) Q: How much should I save for a down payment?
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Most lenders will recommend that you save at least 20% of the cost of the home for a down payment. It is wise to save at least 20% because the more you put down, the lower your monthly payment will be and ultimately you will save on interest costs as well. In the event that you are unable to save 20% there are several home buyer programs and assistance, especially for first time buyers. Check out the lenders that specialize in making the home buying experience a breeze.

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