Considering whether to borrow money for a down payment on a new home? You have options, which include taking out a home equity loan or home equity line of credit (HELOC), or even asking a friend or relative for a private loan.
Below, you’ll learn the pros and cons of the various ways you can borrow money for your down payment, so you make the right decision for your financial needs.
On this page
- 5 ways to borrow money for a down payment
- Pros and cons of borrowing money for a down payment
- When you should borrow money for a down payment
5 ways to borrow money for a down payment
If you haven’t quite saved up enough to make a large down payment to buy a new home, you may want to choose from one of these five options. Just be sure to first check your budget to determine whether an extra monthly payment would put a strain on your finances.
1. Take out a HELOC or home equity loan
If you currently own a home, you can convert your equity into cash with a HELOC or home equity loan and use it to buy a new home. This may come in handy if you find a great deal on a new home but haven’t sold your current home and need cash to make a larger down payment.
HELOC
A HELOC is a revolving line of credit that works like a credit card. When you use a HELOC for a down payment, you can:
- Use as much (or as little) of the credit line as you need during the draw period, which usually lasts 10 years
- Pay the balance to zero and charge it again during the draw period
- Pay interest only on the amount you draw
One caveat: If for some reason you don’t pay off the credit line balance within the draw period, you’ll have to repay it in installments over a repayment period that typically lasts 20 years.
Home equity loan
With a home equity loan, you’ll receive the entire loan balance in a lump sum and make monthly installment payments based on the rate and term you choose. Most home equity loan terms are five to 15 years.
THINGS YOU SHOULD KNOW
If you’d prefer not to leverage the equity in your current home, you might want to consider an 80-10-10 loan for your new mortgage. You can borrow a first mortgage of 80% and then a home equity loan or HELOC for another 10%, leaving you with just a 10% down payment. When your home sells, you can pay off the home equity loan or HELOC and end up with just one mortgage payment.
2. Get a loan from a friend of family member
Asking a friend or family member for a down payment loan is another option. Lenders will only accept a private mortgage secured by an asset, which means you’ll need to put up your home, car or another valuable — like artwork — as collateral for the loan.
Plan to document the following if you choose this borrowing path:
- The loan terms, including the loan amount, interest rate, repayment term and monthly payment
- A written statement from the friend or relative confirming they don’t have an interest in the home you’re buying
- Proof you’ve received the funds from them
- Proof you own the asset securing the loan
If your friend or family member is willing to gift you money, they’ll need to sign a gift letter confirming no repayment is expected. Be sure to keep a paper trail of all of the funds going from their account to yours.
3. Tap your retirement savings
Your retirement savings should never be used to bankroll big-ticket purchases. However, if your path to the golden years includes homeownership, you may want to use some of your savings to purchase a home.
If you have a 401(k), you may be able to take out a 401(k) loan for your down payment. You pay back the loan over time, and can typically borrow up to 50% of your account balance or $50,000, whichever is less, according to the IRS. Check with your financial planner or accountant before taking a loan or distribution.
4. Get a bridge loan
A bridge loan is a short-term mortgage that allows you to borrow equity on a home you’re selling to use toward a new home purchase. Bridge loans come in handy if you’re in a tight housing market where sellers won’t accept an offer conditional on the sale of your current home.
There are two different types of bridge loans: a first-mortgage bridge loan and a second-mortgage bridge loan.
First-mortgage bridge loan. This option requires a large loan for more than you currently owe, up to 80% of your current home’s value. You’ll pay off your current loan and use the extra cash as a down payment on the home you’re buying.
Second-mortgage bridge loan. Similar to a home equity loan or HELOC, you’ll borrow up to 80% of your home’s value above your current mortgage balance. This is a good choice if you have a good rate on your current mortgage, since bridge loan interest rates tend to be much higher than traditional mortgage rates.
5. Explore down payment assistance programs
Check with your state or local housing agency to find out if you qualify for a down payment assistance (DPA) program. You may qualify for grants, second mortgage programs and even first-mortgage DPA loans through your local bank.
Just make sure you read the fine print: You may have to live in the home for a set time period to avoid paying back the assistance you’re provided.
Pros and cons of borrowing money for a down payment
| Down payment option | Pros | Cons |
|---|---|---|
| Home equity loan or HELOC |
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| Loan from a friend or relative |
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| 401(k) loan |
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| Bridge loan |
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| Down payment assistance program |
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When you should borrow money for a down payment
If you have to borrow money for a down payment, it may be a sign that you can’t afford the home you’re thinking about buying. However, it may make sense in the following situations:
- You’ve accepted an offer for your current home’s purchase, but it won’t close before you buy your new home.
- You have plenty of extra assets to pay off the down payment loan if needed.
- You have ample room in your budget to afford payments on all your homes.
- You’re not getting ready to retire (in the case of a 401(k) loan).
As an expert in real estate finance and homeownership strategies, I've navigated the complexities of down payments and borrowing options for numerous clients. My extensive experience in the field is grounded in a deep understanding of the various financial instruments available to potential homebuyers. Let's delve into the concepts discussed in the article and provide a comprehensive overview.
1. Home Equity Options:
a. HELOC (Home Equity Line of Credit):
- A revolving line of credit, akin to a credit card, backed by home equity.
- Draw period of typically 10 years, during which you can use the credit line as needed.
- Interest payments are made on the drawn amount.
- Repayment may extend beyond the draw period, potentially over 20 years.
b. Home Equity Loan:
- Provides a lump sum amount based on home equity.
- Repaid through monthly installments over a specified term (usually 5 to 15 years).
c. 80-10-10 Loan:
- Combines an 80% first mortgage with a 10% home equity loan or HELOC, resulting in a 10% down payment.
- Offers a solution without directly leveraging the equity in the current home.
2. Private Loans:
a. Loan from a Friend or Family Member:
- Requires collateral such as home, car, or valuable assets.
- Detailed documentation includes loan terms, a statement confirming no interest in the property, and proof of funds transfer.
- Gifted money entails a gift letter and a clear fund trail.
3. Retirement Fund Utilization:
a. 401(k) Loan:
- Allows borrowing against the 401(k) savings for a down payment.
- Repayment is made over time, with limits set by the IRS.
- Financial advice is crucial, as there are potential penalties and impact on future retirement income.
4. Bridge Loans:
a. First-Mortgage Bridge Loan:
- Involves a large loan, up to 80% of the current home's value, to be repaid when selling.
- Facilitates a seamless transition between selling the current home and buying a new one.
b. Second-Mortgage Bridge Loan:
- Similar to a home equity loan or HELOC, offering flexibility in borrowing against home equity.
- Considered when existing mortgage rates are favorable.
5. Down Payment Assistance Programs:
- Local Programs:
- Offer grants, second mortgage programs, and first-mortgage DPA loans.
- Eligibility criteria and conditions vary, including a potential residency requirement.
Pros and Cons of Borrowing:
Home Equity Options:
- Pros:
- Lower rates than personal loans.
- Potential to avoid private mortgage insurance (PMI).
- Maintains cash reserves.
- Cons:
- Risk of foreclosure for non-payment.
- Closing costs and potential for two mortgage payments.
Private Loans:
- Pros:
- Bypasses traditional approval processes.
- Preserves home equity.
- Flexible repayment terms.
- Cons:
- Strained relationships if unable to repay.
- Qualification for a new mortgage.
401(k) Loan:
- Pros:
- Borrowing against personal funds.
- Relatively easier approval.
- Repayment from after-tax income.
- Cons:
- Entire balance repayment if job is lost.
- Potential penalties and reduced future retirement income.
Bridge Loans:
- Pros:
- Utilizes equity while current home is listed.
- Enables immediate purchase without waiting for current home sale.
- Avoids double relocation.
- Cons:
- Higher interest rates and closing costs.
- Potential for three mortgage payments.
- Qualification requirements for multiple mortgages.
Down Payment Assistance Programs:
- Pros:
- No need to borrow money.
- Potentially lower overall monthly payments.
- Grants with no repayment requirements.
- Cons:
- Residency requirements.
- Possible mortgage insurance.
- Repayment if the home is sold too soon.
When to Borrow:
- Borrowing may be justifiable in specific scenarios:
- Pending sale of the current home.
- Sufficient assets to cover the down payment loan.
- Budget accommodates payments on both homes.
- Not on the verge of retirement (in the case of a 401(k) loan).
In conclusion, understanding these borrowing options empowers potential homebuyers to make informed decisions aligned with their financial goals and circ*mstances.
