Cashay logo

Empowering your money

Home financing: How to get a home loan

At a glance:

  • The first thing to plan for when buying a home

  • Borrowing from retirement savings to finance a home purchase

  • Saving or investing to finance a home purchase

  • Using private loans to buy a home

  • Buying a home through seller financing

  • First-time homebuyer programs

  • Government loans to finance a home purchase

  • Summary of how to finance a home

For many of us, buying a home is the beginning of really living. Since it's such a huge investment, there's a lot to work through when you finance a home.

There are qualifications you have to meet, reams of forms and paperwork, delays, and additional costs you may not have thought of. What are the main options available for financing your home?

The first thing to plan for when buying a home

The first thing to plan for when it comes to paying for a home is the down payment. Ideally, you want to have a large stash of savings to pay for your down payment.

The traditional 20% down has returned after several years of being out of sight. It is still possible to get a loan that requires less than 20%, but it is not easy to qualify for like it was in the 1990s and early 2000s.

If you already have 20%, you will not need to pay for mortgage insurance, and you will cut your monthly payments as well. If you can raise more than 20%, so much the better. But if you do not have 20%, there are ways to raise it.

Borrowing from retirement savings to finance a home purchase

401(k)s

If you have a 401(k) plan at work, you may qualify to take loans from it.

Certain conditions for the loan, such as loan fees and the maximum term, are set by your employer, so find out what is involved. There is a maximum loan amount allowed — $50,000 or half of your vested amount, whichever is less. Note that because this is a loan, you must pay it back in a reasonable amount of time with interest.

IRAs

If you have an individual retirement account (IRA), you can withdraw up to $10,000 without penalty if the money is used for a first-time home purchase.

You must use the money within 120 days. The $10,000 is a lifetime limit, and you may need to pay income taxes on it. However, you do not need to pay it back.

Saving or investing to finance a home purchase

The more you have saved up, the less you will have to rely on loans, and the less you will have to pay each month for your mortgage (and the interest on it).

Begin saving as early as you can — some people even start in their teens. Some work an extra job or two to save up funds.

If you plan to buy a house fairly soon, such as within a year or two, you probably won't want to risk your money. Low-volatility investments such as certificates of deposit, money market accounts, and regular savings accounts can be ideal. You will earn some interest or dividends, but very little growth.

The median age of home buyers has risen since 1981. (Graphic: David Foster/Cashay)
The median age of home buyers has risen since 1981. (Graphic: David Foster/Cashay)

If you plan to buy a house years down the road — say, five years or more — you can afford to put your funds into an investment with growth potential, such as a stock or a mutual fund, or perhaps a commodity such as precious metals.

Fluctuations tend to even themselves out over the course of years. These investments carry the risk of loss and should not be entered into without a thorough understanding of their risks.

There is also the option of splitting your money among several investments to achieve different returns.

Using private loans to buy a home

Financial institutions aren't the only places willing to lend people money.

Your family or friends might just want to be your private bank. If you haven't considered this avenue, you may want to at least consider the pros and cons.

Getting a private loan need not be — in fact, should not be — informal or unprotected.

You draw up a contract with payment terms and a schedule of repayment. You can structure it in the same way that an institutional loan is structured. The private lender will hold a lien and can require late fees, just as a bank might. If you default, the lender can foreclose.

Advantages

Private loans have some advantages over loans from financial institutions:

  • You can negotiate the interest rate. The result could be a relatively low one for you.

  • Your lender might still get a better interest rate than he or she could at an institution.

  • You can draw up favorable contract terms, such as a longer payback time.

  • You could be more flexible if problems arise, such as a job loss, than you could be with a bank.

  • You can refinance for little or no cost, depending on what you agree on.

Do the paperwork

Simply handing a person money and expecting repayment isn't a good idea. A private loan should be structured like a business deal, that gives it an air of legitimacy and gravity. It also protects both the borrower and the lender with legal recourse if, for example, the relationship goes sour or the lender decides he wants all the money back for some reason.

Draw up a promissory note that explains your legal obligation to repay the loan, all payment issues (dates due, how often, etc.), penalties, and the interest rate. Draw up the actual mortgage (or "deed of trust," in some states), which puts the home up for collateral in the event you default. Also, draw up a repayment schedule.

Above all, treat a personal loan with the utmost seriousness. Both you and the lender can come out ahead with one. Abusing a loan can destroy the goodwill of a family or friend and even your larger relationship network.

Buying a home through seller financing

Though this is not very common, if a particular home strikes your fancy and you have no other way to pay for it, the seller of the home could finance it for you. This is not without risks, however.

Because the legalities and tax issues can be complicated, parties interested in seller financing often enlist the help of attorneys, tax advisors, and sometimes loan servicers.

How it works

In seller financing, the seller extends credit to the buyer for the balance of the home, and the buyer begins making payments. The loan is typically spelled out in a promissory note and includes the terms of the loan — interest, monthly payments, penalties, etc. The loan is also registered with the local government.

Loans vary in length and can be amortized over a period as long as 30 years to keep the monthly payment low. That does not mean that the seller will want to wait 30 years to unload the home. That's why many of these loans have balloon payments due in a few years. By that time, enough equity may have built up that the buyer can go to a traditional lender to refinance the loan.

Types of seller financing

Several forms of seller financing exist:

  • Land contract. The buyer makes payments to the seller and receives title only after the last payment. Until that last payment, the buyer has what's called equitable title to the property.

  • Lease. The seller leases the home to the buyer for a certain term, then sells it to the buyer at some point after that. Based on the contract, the lease payments may be credited to the home's purchase price.

  • All-inclusive trust deed (or all-inclusive mortgage). In this form, the seller carries the mortgage and the promissory note until the home is paid off, then signs it over to the buyer.

  • Second mortgage. If the buyer has less than a 20% down payment, traditional lenders may not want to finance. The seller, therefore, can step in and provide a small loan to make up the difference.

Strategic considerations

The buyer and seller can fill out the traditional paperwork associated with mortgage loans — a loan application, credit check, employment check, a sales contract, appraisal, mortgage contract, etc. This helps protect both of them in the event of adverse circumstances.

Requiring a down payment also works in the favor of both parties. Buyers feel more committed to the home, and sellers reduce their risk of loss.

Another advantage is that commissions and various fees can be omitted, thus putting more funds into the hands of the buyer. Seller financing deals can also be more negotiable than those from a bank, the interest rate, down payment amount, and other aspects can be less strict.

First-time homebuyer programs

If you are a first-timer at home-buying, the government wants to help you out. There are programs just for you that offer financial assistance. They come with restrictions and rules, however, which you should consider carefully.

Your local bank, credit union, or other financial institution likely works with first-time homebuyer programs and can help you learn about them.

Programs can vary, but some common features include the following:

  • A down payment less than the usual 20%. With some, no down payment at all.

  • A limit on fees that lenders can charge.

  • Access to grants and loans that offset the purchase price of the home.

  • Subsidization of interest costs.

Real estate agent Scott Robbins stands in front of a home, in suburban Salt Lake City. (Photo: AP Photo/Rick Bowmer)
Real estate agent Scott Robbins stands in front of a home, in suburban Salt Lake City. (Photo: AP Photo/Rick Bowmer)

Limitations

There are restrictions on who can qualify. Restrictions vary, but typically include:

  • Certain income requirements

  • A sufficient credit score

  • A maximum dollar value of the loan

  • Residence: you must actually live in the home

  • Physical condition of the home

  • Minimum residence: you may have to live in the home for a minimum number of years

As well, you can qualify for the "mortgage credit certificate" if you meet certain criteria. It lets you claim a tax credit for some portion of the mortgage interest you pay during the year.

Government loans to finance a home purchase

If financing a home is difficult for you, you may benefit from a government loan program.

U.S. Department of Veterans Affairs

VA loans are available to eligible veterans. The VA does not itself make loans. Rather, it guarantees a portion of the loan that you have with a lender. It will pay the lender the portion of the loan if you should default. You will then owe the VA for the balance.

Advantages of VA loans include no down payment required, more favorable interest rates (because of the guarantee), and no mortgage insurance premiums. More information is available at www.benefits.va.gov/homeloans/.

Federal Housing Administration

The FHA also guarantees loans. Down payment requirements are low, closing costs can be financed, and mortgage insurance may be waived. More information is available at https://www.hud.gov/buying/loans.

Both of these programs have restrictions and eligibility criteria.

Other government loans

The states and many cities have loan programs of their own.

Summary of how to finance a home purchase

Most of us will never be able to plunk down cash to buy a house. Instead, we will have to take out a loan and then spend a long time paying it back. The day we finally pay back the loan is the day we feel a long-awaited freedom, as our house is now owned free and clear.

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

Read more information and tips in our Buying/Selling a home section

Read more personal finance information, news, and tips on Cashay

Follow Cashay on Instagram, Twitter, and Facebook