In Pursuit Of a Down Payment
With Lenders Wanting More, Buyers Have to Dig Up New Sources of Money

By Nancy Trejos
Washington Post Staff Writer
Saturday, November 3, 2007

Even for people who have money, coming up with a down payment to buy a house has become a lot more challenging in recent months.

Take Peter McGarvey, who in September found a house big enough to accommodate his family of four and close enough to the Metro that his wife could commute to work. A bidding war ensued over the 2,000-square-foot home, in Takoma Park. He offered $710,000 and won.

Then came the hard part: making enough of a down payment to get a good rate on a loan and keep the monthly mortgage payments manageable.

Because he had not yet sold the house he already owned, he had to cobble together a down payment from other sources. "We have lots of equity in the house, and we have money saved up. Unfortunately, most of it is in retirement funds and mutual fund investments," McGarvey said.

Here's how McGarvey and his wife came up with 10 percent to put down, plus the cash they needed for closing costs: $25,000 was left from the sale of mutual funds about a year ago, $25,000 came from their parents and another $50,000 came out of the Thrift Savings Plan, a retirement program for federal employees that McGarvey's wife has through her job at the Environmental Protection Agency.

Even a few months ago, borrowers did not have to go to such lengths. That's because it was easy to get a mortgage that required little or no money down. In fact, four out of 10 first-time buyers used no-money-down mortgages in 2005 and 2006, according to surveys by the National Association of Realtors. The median down payment for first-time buyers in those years was 2 percent of the purchase price, meaning half paid more and half paid less.

But now that those loans are being blamed for a spike in foreclosures, many lenders are no longer offering them or have become pickier about who gets them. The theory goes that borrowers who put a lot of their own money into properties will be less willing to default and walk away.

"Traditionally, the more someone has invested, the better the payment record," said Charlie Vance, manager for the Washington and suburban Maryland division of Wells Fargo Home Mortgage.

A New Norm: 5 Percent

That's not to say that lenders are requiring down payments of 20 percent or more, which was the norm until the mid-1980s.

"I don't think we're there yet," said Franco Terango, consumer real estate executive for the mid-Atlantic branch of Bank of America.

There are still some low-down-payment programs. Federal Housing Administration-guaranteed loans, intended primarily for low- and moderate-income, first-time home buyers and others who don't have enough for a down payment, call for 3 percent down. If you're a veteran or a member of the military, you can still get 100 percent financing.

But if you don't fall into any of those categories and you're looking for a conforming loan, one that's eligible for purchase by Fannie Mae or Freddie Mac, "you're talking about a minimum of 5 percent down," said Guy Cecala, publisher of Inside Mortgage Finance. On a $400,000 house, that's $20,000.

If you need a jumbo mortgage, which is above $417,000 and cannot be bought by Fannie or Freddie, you'll probably have to come up with 10 percent of the purchase price in cash, Cecala said. On a $500,000 house, that would be $50,000. Loans purchased by Fannie and Freddie are considered less risky to investors and at the moment have better rates than jumbo loans.

The sudden shift in lenders' attitudes means many buyers now must take a substantial amount of money to the closing table, particularly in high-cost areas such as the Washington region.

The best source for a down payment, lenders and financial planners said, is the borrower's own funds. "If you've got the cash, that's the best way to do it," said Heather Evans, vice president and wealth management adviser at Merrill Lynch in Tysons Corner.

Tapping the 401(k)

But if you're like most Americans and haven't saved tons of money over the years, does that mean you won't be able to buy a home?

Not necessarily, lenders and financial planners say. There are several options.

Prospective homeowners can take money out of their 401(k) or other retirement plans if the home will be their primary residence. There are two ways to do this. The less desirable way, financial planners said, is to make a "hardship withdrawal," but that is subject to a 10 percent penalty from the IRS, and the amount withdrawn is taxable as income.

A better -- but not risk-free -- option, they said, is to borrow the money from a 401(k) account, which many employers allow for such reasons as purchasing a principal residence or paying college tuition. Typically, borrowers have five years to pay the account back, or longer if the loan is specifically for a home purchase. Borrowers have to pay interest on the loan. But they are essentially borrowing their own money, and what they pay will go back into their 401(k) account.

The downside is that the funds withdrawn are not earning returns on investment, so the borrower will have less money in the account when he or she retires. Plus, the loan repayments are made with after-tax dollars, replacing what had been pretax dollars. And if the borrower loses his or her job or switches to a new employer, he or she must repay the loan much sooner than expected, usually within 60 days.

Patrick Kennedy, vice president in charge of wealth management services for TIAA-CREF Asset Management, cautions against taking money from a retirement plan by either method because of the tax implications and the loss of wealth. But if someone chooses to do so, he said, the loan should be repaid as quickly as possible. "The government has made it easy, and it's very appealing, but you have got to look at this as a short-term bridge, not a long-term road," he said. "People have to think through the implications of what they're doing."

Kimberly Lee, an auditor for Constellation Energy Group in Baltimore, chose to dip into her 401(k). At 28, she felt it was time to become a homeowner, and she found a rowhouse in Baltimore for $249,000. She had been saving money since graduating from college but didn't want "to completely drain my savings," she said.

She put about $8,000 of her savings into the down payment. To make a 5 percent down payment, she pulled the rest from her 401(k) account. The loan repayment comes directly out of her paycheck.

Because she has a steady job, she thought it was a safe thing to do. "What comes out is $15 or $20 biweekly. That's like nothing to me," she said.

Investments Can Pay Off

Selling stocks, bonds or mutual funds can also be a good way to raise a down payment, financial advisers said. But the proceeds could be taxable. Borrowing against the investment portfolio might be a better alternative, financial advisers said.

"If you sell things, there will be tax implications," said Evans of Merrill Lynch. "You want to get specific guidance on that."

Withdrawing from an IRA, or individual retirement account, is also an option. The IRS does not allow borrowing from an IRA, but a first-time home buyer can make a one-time, penalty-free withdrawal of up to $10,000. The downside: The borrower might owe tax, depending on the type of IRA.

A prospective homeowner might also want to consider borrowing from a cash-value life insurance policy, advisers and lenders said. There's no tax on loan proceeds. But they pointed out that most first-time home buyers don't have much money in their policies.

Another route would be to get a gift from a relative or friend. The lender will generally ask for a letter from that person saying that the money is a gift, not a loan that will have to repaid. According to the National Association of Realtors' 2006 survey of home buyers and sellers, 22 percent of first-time home buyers opted to do this. Only 3 percent of repeat buyers did; most of them used proceeds from the sale of one residence to pay for the next one.

If you're trying to get a conforming loan, though, you typically cannot rely on just a gift. In that case, the borrower still has to prove that 5 percent of the money going into the purchase comes from his or her assets, said Kevin Connelly, vice president of BB&T. That is, unless your relatives are really generous: Lenders generally waive the 5 percent requirement if the gift covers 20 percent of the purchase price, Connelly said.

Borrowers should also research down-payment-assistance programs. There are many, some run by government agencies, some by nonprofit organizations, churches and other community groups. Many employers also offer help.

Jeff Colacurcio and his wife, Lauren, were able to buy a $485,000 four-bedroom house in Falls Church through a program offered by his employer, Fannie Mae. He has worked as a financial analyst for the company for two years. The couple made a 12 percent down payment, of which more than half came from the Fannie Mae program. The rest came from the couple's savings.

If it hadn't been for the program, the Colacurcios would still have been able to afford the house, but they would have drained all their savings.

"We had a cushion that we wouldn't have had left over that allowed us to keep the savings and do the things to the home that we wanted to do," Colacurcio said.

If all else fails, there are other creative ways to come up with down payments. Pull out that vintage Gucci purse and sell it on eBay. Sell your bike. Sell your car.

Some advisers and lenders said that if a prospective homeowner has to go to great lengths to come up with money, maybe it's best to wait until he or she can save enough money the old-fashioned way. Or maybe buying a fixer-upper rather than the dream home would be the way to go.

"It doesn't have to be a McMansion," said Evans of Merrill Lynch. "Homeownership should be within your budget."

But for Darrell Perry and his wife, Delia Goncalves-Perry, becoming homeowners felt like the natural next step after getting married.

They scrimped and saved, dry-cleaning only the essentials, giving up expensive coffee, eating in and not buying new sneakers. A lawyer who performs in a hip-hop band in his spare time, Perry also set aside all the money he received from the sale of his group's CDs.

Then came their August wedding. The money poured in -- about $10,000. "People had the intuition: They don't need dishes; they could use money," he said.

All in all, the couple ended up with $26,000 for a down payment. They recently were outbid on a house that sold for $500,000. Their search continues.