First-Time Home Buyer Down Payment Strategies

Low-down-payment loans, assistance programs or gifts can help first-time home buyers clear the down payment hurdle.

Saving away a pile of money for a down payment on your first home is easier said than done. First-time home buyers often combine saving for a down payment with other financial strategies. The best one will help you clear the down payment hurdle without jeopardizing your finances in the long run.

Here are some options that first-time home buyers use to come up with a down payment. Not all of them will be right for you, so consider the benefits and drawbacks carefully.

1. Low-down-payment mortgages

Traditionally, lenders have preferred 20% down, but many low-down-payment options are available, especially to first-time buyers:

• VA loans, which are backed by the Department of Veterans Affairs, and USDA loans, backed by the Department of Agriculture, offer 0% down payment options for borrowers who qualify.

• FHA loans, backed by the Federal Housing Administration, allow down payments as low as 3.5%.

• Conventional loans, which aren’t backed by the government, offer down payments as low as 3% to first-time home buyers with good credit.

A smaller down payment requirement may enable you to buy a home and start building equity sooner.

The drawbacks: Making a small down payment can trigger extra expenses. Mortgage insurance, which protects lenders against loans that default, is required on all FHA loans and on conventional loans with down payments less than 20%. VA loans have a funding fee, which can be rolled into your monthly loan payment. A lower down payment usually means you’ll pay a higher interest rate.

2. State and local down payment assistance

Many states have down payment assistance programs, implemented by government agencies, nonprofits, foundations and even employers. The assistance usually comes in the form of grants or zero-interest, forgivable loans. The programs can have a geographic focus as wide as the nation or as narrow as a city. There are also hyperlocal initiatives targeted as tightly as neighborhoods and even house by house.

Often, it’s a matter of matching a property to a program, based on a home’s location and price.

Down payment assistance is often combined with favorable mortgage interest rates or tax breaks. Applicants may be required to take first-time home buyer classes, which help prepare them for successful homeownership.

The drawbacks: Programs usually set a maximum sale price and some have income limits, so not all home buyers will qualify. However, it’s still worth checking out programs in your state.

3. Down payment gifts and loans from family

It’s not uncommon for first-time home buyers to get help from family members. Of all home buyers ages 28 and younger (many of whom are likely first-time buyers), 28% used a gift from a relative or friend to make a down payment, according to a 2019 report from the National Association of Realtors. Of all buyers ages 29 to 38, 21% used a gift.

Down payment gifts are acceptable to lenders. But applying a gift toward a down payment involves more than depositing a check.

The donors will have to verify in writing not only that they made the gift, but that they also have the financial ability to make such a donation. That will require them to provide bank statements as proof, along with a letter confirming that the donation is a gift and not a loan.

The drawbacks: Using a gift to supplement savings can help first-time home buyers clear the down payment threshold. But buyers who have to rely exclusively on gifts from family members may be unprepared for the full cost of owning a home.

4. Retirement account withdrawals or loans

Some first-time home buyers tap retirement savings for a down payment, but this option should be approached with caution.

The rules and consequences for using retirement money for a down payment before age 59½ vary by the type of account:

• Employer-sponsored 401(k) plans may allow for early withdrawals or loans. You’ll pay income taxes and an additional 10% tax penalty on an early withdrawal. If your plan allows a loan, you must repay the money with interest to avoid income taxes and a penalty. Some 401(k) plans give you more than five years to repay a loan for a primary home. If you leave your job, loans must be repaid or rolled into an eligible retirement account by the next tax filing deadline, or you’ll pay taxes and a penalty on the borrowed money.

• Traditional IRA withdrawals for first-time home purchases are allowed, up to $10,000. You will pay income taxes on the withdrawn money, but won't face an additional penalty if the money is used to buy or build a first home.

• Roth IRA withdrawals are tax-free and without penalty for a first-time home purchase if you’ve had the account for at least five years.

The drawbacks: Taking money out of retirement savings early can set you back on long-term savings and make it hard to catch up. Plus, you miss out on tax-free growth on any of the money you withdraw. Financial planners generally don’t recommend this strategy because most people are already behind on retirement saving.