Today we dive into the world of down payment assistance programs and how they can help you achieve your dream of homeownership. With housing affordability becoming a growing issue, these programs are becoming increasingly important for first-time buyers.
In this article, we will discuss:
- The different types of down payment assistance programs and how they work
- The various requirements needed to be considered for these programs, such as income, credit score, and residency restrictions
- The upsides and downsides of using down payment assistance programs, including the impact on your buying power and potential disadvantages in a competitive seller’s market
- Tips on how to find and apply for these programs in your local area
Whether you’re struggling to save for a down payment or just need a little extra help with closing costs, down payment assistance programs can be a valuable resource in your home buying journey. Keep reading to learn more about these programs and how they can help you achieve your homeownership goals!
Getting some help
In November of 2022, Freddie Mac, a major provider of mortgage loans, released the results of a home ownership survey regarding the top issues home buyers are facing. The number one issue was saving for a down payment.
If you’ve been keeping up with us so far, you should know that you only need about a 3 to 3.5% down payment to buy house, plus another 2% for closing costs. But saving up that amount can be pretty difficult, especially with the rising costs of everything. The tactics we went over previously may not be for everyone, and the timeline might be too long since housing affordability is a growing issue.
That’s why there are down payment assistance programs available to help you buy a home. These programs come in many forms and they vary greatly from city, to county, to state. Even your income or job can affect what kinds of down payment assistance you might be eligible for.
But let’s make one thing clear: there is no such thing as free money. One way or another, the funds come from somewhere. Most of these are going to be grant programs that are funded at a city or county level; these are probably your lowest-cost options. There are others that will require payment in return, plus interest or a percentage, or it’s in exchange for a higher interest rate on your loan.
Getting the down-low on down payment assistance
Let’s start by discussing how down payment assistance works. When you buy a house, you need to pay for the down payment as well as closing costs. These costs are unavoidable; you’re going to have to pay them no matter what. Now, there are some circumstances where the cost isn’t totally on you: the seller might contribute, you might be able to get a portion of the costs as a gift, there might be some lender credits, etc. But these types of circumstances are not guaranteed. In general, for an FHA loan you’ll be paying 3.5% down while a conventional loan will be at least 5% down and about 2-3% in closing costs. So, a good estimate for the total funds you’ll need to have available is at least 6% of the purchase price of the home.
Down payment assistance usually comes in the form of a loan, such as a low or no-interest loan that acts like a second mortgage on your home, or a grant that’s forgiven after a specified period. There are so many programs out there, and even some new federal programs being legislated as you read this. Have you heard of the Down Payment Toward Equity Act? Although not yet approved, this is a federal program aimed at helping first time home buyers who are the first in their family to buy a home. The program would provide anywhere from $20,000 to $25,000 in assistance to eligible participants. Now, if this passes, it would allow a participant to use the grant so long as they don’t move, refinance, or sell their home for five years. There’s no payback required. If a participant does any of these in under five years, they would have to pay back a portion of the grant on a graduated scale.
This is a great example of how many of these programs function. Essentially, you’re given a portion of your down payment based on specific requirements. So let’s take a closer look at what those requirements are and how to be considered for down payment assistance.
Down payment assistance programs are normally limited by income; to qualify, you must have an income that is below a certain level for the city or county. Some programs are even more restrictive, requiring you to be under the average income in your area. Some programs use other income measurements, which are typically more forgiving, and there are some programs that don’t have a limit at all.
Take San Diego for a regional example. There are some down payment programs that use the Cal HFA income limit of $211,000. But there are some programs at the county or city level that have drastically different limits; for the city of San Diego, the combined income limit for a married couple would be $83,000 annually. You can see there’s $130,000 in difference between the income limits from one program to another, which are based on the different ways they measure it.
In addition to limits concerning a buyer’s income, there are also limits to how much a buyer can purchase. Most of these programs align with an FHA or conforming loan limit, depending on the type of program. If you’re in a high cost living area, this could impact the availability of homes that qualify for a program. There’s also the potential that there won’t be any homes available that fit the program’s limitation at all.
In terms of residency restrictions, some programs may be limited to people who are already residents or who have a history of residency in a given city or county. For instance, if you’re looking to buy a home in a city that you haven’t lived in for two full years, there may some city grant programs that you won’t be eligible for.
To qualify for a down payment assistance program, in most cases you’ll need fairly good credit. A few programs will go as low as a 620 FICO score, but most require 660-680, and sometimes even 700, to really get enough buying power for the whole deal to make sense. There may be programs out there with a lower credit requirement, but there are very few that would allow a credit score under 660.
A few other miscellaneous requirements:
- You need to be a first time home buyer, which usually means you haven’t owned a home for at least three years
- There can be employment or demographic restrictions OR benefits: some underprivileged groups may get preference, and some types of employment (such as first responders, firefighters, police, medical professionals, etc.) typically take priority as well
You qualify! But for how much?
As far as the programs themselves, they’ll usually pay about 2%, 3.5% or up to 5% of your down payment and closing costs. There are even some programs that pay up to 20%. But how do you actually get set up with a program to begin with? Let’s dig into it – keep in mind, this is to give a general idea of how these kinds of programs work, so we won’t go over any specific programs. To get started, you’ll definitely want to talk to a loan officer and do some extra research if you’re interested in getting down payment assistance. You’ll want to be familiar with how certain programs work and what you’re looking for in terms of assistance.
Programs that offer 2% are more of an assistance than outright paying your down payment or closing costs; it’s really about closing the gap and helping your make up the difference between what you’ve saved and what you’ll owe. These 2% programs tend to have more favorable interest rates, and often their payback schedules are more flexible since there is less risk involved for the lender.
A home will normally have some equity in it already, so 3.5% down payment programs help those that have a little. The interest raates and fees are better than some of the other programs. This covers the cost of the down payment on an FHA loan or to cover the cost of down payment while receiving seller credits or gift funds for the closing costs. This is a pretty common scenario to see. A higher interest rate on these loans will help offset the cost of the down payment. But if you’re able to get the seller to help cover the cost of your closing costs, you may not have to come up with much money out of pocket (may just a few thousand dollars). The 3.5% is given at about a 1% higher interest rate than your standard loan’s interest rate, but the grant is forgiven after only six months. That means you can refinance or note that the money is no longer owed.
5% down payment assistance programs can cover both closing costs and the down payment on an FHA type loan. These are less common because they’re typically more difficult to come by, have more restrictions, and usually require a much higher credit.
In California, there’s a 20% program that just launched this month (March 2023). This program’s actually what they call a shared appreciation loan, which means they’ll loan you up to 20% of the purchase price that you have to pay back when you refinance, sell, or pay off the home. You’ll also have to pay up to 20% of the appreciation on the home as well. That money then gets reinvested back into the program for future buyers. The best way to think of this program is that they’ll give you 20% that you have to pay back in. There’s no interest on it, and then you get to keep 80% of the profit you make from the home sale. It’s a great way to have either fully cover the down payment with closing costs paid, or to have a 20% down payment so you don’t have to pay mortgage insurance. This should help many buyers who would otherwise be priced out of a loan because the down payment will help lower the principle amount, leading to lower payments.
Pros and Cons
As great as these programs may sound, depending on your situation there are always a few upsides and downsides to any option. To help you think about whether or not a program makes sense for you, let’s go over some pros and cons.
- Less money required to buy a home
Right? So this is the big obvious one. You don’t have to have a full down payment saved to buy a home Down Payment assistance programs can help you cover the full cost of the down payment and closing costs, which is especially beneficial for first time home buyers who may not have a lot of money saved up, or who can’t use the equity earned from a previous home sale, to help pave the way for a new purchase interest rate and payback schedules.
- More favorable interest rates + flexible payback schedules
Some programs actually give more money or have better rates for those at specific income levels.
- Below the county average for refinancing
In many cases, you can refinance your loan after a specified period, and reduce your interest rate if the interest rates have dropped, and also not have to pay back the down payment. In some programs, a one-time refinance is allowed, even if the down payment loan is on a 30 year term, which means you could refinance, get that lower rate, and you don’t have to worry about that second mortgage that’s on there. These programs can give you more buying power. With a program like Cal Hess, 20% down, you may find yourself with more buying power at the same monthly payment, allowing you to buy when you may have been priced out before.
- Limited funds
Many of the state and county programs have funding limits. They have a set amount at the beginning of the year, and when those are used up, you have to wait till the next year till they re-fund. Once that funding runs out, the programs are put on hold until the next round of funding.
- Less flexibility in housing
Many of these programs have occupancy restrictions and nearly all require you to be the primary occupant, so you can’t rent the home or buy it as an investment property. You usually cannot have a co-borrower on the loan either who will not also be occupying the home. This means you can’t have a family member cosigned who isn’t planning on also living there.
- Restrictions on when you can move, sell, refinance, etc.
Some programs will require a full payment of the grant or loan if you move within a specified time period, which could be as little as five years. So if you aren’t stable and where you’ll be living long term, or maybe with your career, then you may find yourself having to pay back the entire down payment after selling.
- There’s a lot more paperwork…
This one pretty much speaks for itself…I mean, who likes more paperwork?
- Longer processing times
These loans often take longer to process, and many times they have to go through multiple rounds of underwriting. The first like your normal loan, and the second with a down payment assistance program. Because of this, there can often be delays in closing; where a normal escrow is about 30 days, an escrow with down payment assistance could stretch to as long as 45 days.
- Your offers may look like a less qualified buyer
When you submit an offer, the seller will be be looking for the most qualified buyer. Unfortunately, with down payment assistance programs, you may not be seen as the most qualified buyer because of the additional paperwork, potential delays in closing, and the knowledge that you don’t have the funds to pay for the down payment or all of the closing costs. Those with high earnest money, high down payments and shortest terms, often went out simply because they’re making a stronger offer. In a highly competitive sellers market, this could be a huge disadvantage.
Now, there are always going to be upsides and downsides, right? Just like everything, weigh your options and see what makes the most sense for you. This is where it’s vitally important to have a lender who understands down payment assistance and a real estate agent who can make sure that the seller’s agent understands the process and situation to make sure that they take your offer seriously, as well as to help you be the most prepared buyer possible.
So: you know you’re interested in applying for down payment assistance, and you’ve made yourself familiar with the options. Now what? How do you actually get started?
Most government housing agencies offer some sort of program, so it’s worth exploring what’s available in your area. Your local HUD office should have more information about these types of programs and eligibility requirements for each one. Definitely check with your county in city two in order to see if they have any resident programs. Most lenders are gonna have down payment assistance options, so make sure to speak to your loan officer, ask them what types of scenarios are available for you, but make sure that you get a lender who understands the process and can explain it to you so that you don’t find yourself in over your head.
When you’re buying a house, you’ll need to fill out a normal loan application. You’ll also have your credit run, which will always be important since your loan officer will use that information to help determine which programs you may be eligible for. Income, credit, and location are all important factors and down payment assistance programs, so be sure to let them know what areas you’re looking at. You could even give them some example homes and they can look to see if those would align with these programs.
Is it all worth it?
You might be asking yourself, “Should I use down payment assistance?” It’s not for everybody, but it certainly is a great option to look into, especially if it’s the difference between you being able to buy a house and, well, not.
Down payment assistance programs are a great way to buy home when your funds may not be enough for the lower three and a half percent FHA down payment plus closing costs. You’ll want to make sure that you understand all of the rules and potential downsides. And make sure that the program offers enough flexibility for you in your future plans.
These programs to work really well with those who have good jobs, good credit, but are just struggling to put enough money away for a sizable down payment with all of the rising costs we’re seeing. This may also be a great program for someone who has the down payment but isn’t quite there yet with the closing costs, and can use this to make that gap up so that they can buy a home today instead of waiting 3, 6, 12 months to save up for those extra closing costs while home prices continue to go up.
Being priced out of the market because you don’t have enough of the down payment shouldn’t stop you from seeking other pathways to home ownership. With the right income and credit, there’s likely a down payment assistance program out there that can help you.