Buying your first home can be equal parts exciting and stressful. Beyond just the purchase price, it’s important to understand the process, available financial strategies, and all the costs associated with your investment. Common questions we see early on in the homebuying journey include:

• How much of my personal funds should I use toward a down payment?
• How much of the purchase price should I use when applying for a mortgage?
• Should I consider other financial strategies?
• What other costs might I not be aware of?

The reality of today’s housing market

Before we take a closer look at your expense, it’s important to understand the current housing market and how first-time home buyers are seeking assistance from their loved ones

The median U.S. household price surpassed $400,000 in 2022, more than doubling in a 10-year span and increasing by around $100,000 in price since 2020. While down slightly from its recent peak, mortgage rates remain in an elevated environment since a spike from the pandemic’s ultra-low rates.

The National Association of Realtors (NAR) releases a monthly housing affordability index to gauge American’s home purchasing power, which reached its lowest level on record in 2023. However, the outlook for 2024 may not be so dire: According to the most recent NAR outlook, the national index for housing affordability was at 105.50 as of January 31, 2024. An index above 100 signifies that a family earning median income has more than enough income to qualify for a mortgage loan on a median-priced home, assuming a 20% down payment.¹

While the index has risen in the first months of 2024, the imbalance of supply and demand in the housing market continues to keep competition high. With elevated demand due to changing demographics and a lagging supply of new housing units since the Global Financial Crisis, there are several complications on the path toward purchasing your first home.

To bridge this purchase gap, more and more first-time buyers are turning to their parents. According to a 2023 survey taken by Redfin, 38% of recent homebuyers under age 30 either used a cash gift from a family member or an inheritance to afford their down payment.

Down payment – The entrance fee

The journey begins with evaluating how much you can afford for a down payment. Once you have this amount in mind, consider what percent of the purchase price you would like to put as a down payment.

Oftentimes, 20% is considered the standard down payment amount, but this is not the only option: Some loan programs allow for down payments of less than 5%. When deciding how much you should put down, assess your budget, explore down payment assistance programs, and understand the implications of different down payment amounts on your monthly mortgage payments.

Choosing a mortgage – One foot in the door

Before selecting a mortgage lender, it’s key to understand the different types of mortgages available to you. First, take a look into your current financial situation, including your credit score, and debt-to-income ratio. As you shop around, you will notice lenders have varying requirements; therefore, you should consider which lender fits your financial profile.

There are two main loan categories, conventional and government-backed.  

1. A conventional loan is a type of home loan backed by private lenders. One of the reasons why first-time homeowners steer away from conventional loans is that they generally require a credit score of at least 620 to qualify for more favorable interest rates.
   
   In addition to the higher credit score, conventional loans generally have higher down payment requirements to avoid private mortgage insurance (at least 20% down is recommended). It is always best to explore all your options and there are many resources where you can compare the various private lenders in the market.
2. A government-backed loan is insured by a government agency. These loans are designed to make homeownership more accessible for individuals who may not qualify for conventional loans due to various reasons. Some of these include:
   • FHA loans: Insured by the Federal Housing Administration, FHA loans are popular among first-time homebuyers. They typically have more flexible qualification criteria, lower down payment requirements (as low as 3.5%) and may accommodate borrowers with lower credit scores.
   • VA loans: These are guaranteed by the Department of Veterans Affairs and are available to eligible veterans, active-duty service members, and surviving spouses. These loans often require no down payment and have more lenient credit score requirements.
   • USDA loans: These are backed by the U.S. Department of Agriculture and are designed to encourage homeownership in rural and suburban areas. They often feature no down payment requirements and offer low-interest rates.

Overall, there is no correct answer on which mortgage to select. The choice between conventional and government-backed loans depends on your financial standing and homeownership goals.

Intra-family loans

Another option to consider when purchasing your home is entering into an intra-family loan with your loved ones. An intra-family loan allows you to take a loan from a family member acting as the “bank” for any amount of the home’s purchase price, and often at a discounted rate to a traditional bank loan.

The terms of the loan found in the promissory note provide flexibility to both the length of the loan as well as the payment frequency. Customization of the intra-family loan can allow for different levels of budgeting toward a down payment vs. a mortgage.

It is required that a minimum interest rate set by the IRS is included in the loan, reinforcing that the loan is not treated as a gift against the lender. Released monthly, the applicable federal rate (AFR) sets the term of the loan over three different time periods:

• Short-term AFR: Up to three years
• Mid-term AFR: Between three and nine years
• Long-term AFR: More than nine years

When considering the use of an intra-family loan, keep in mind that the lender has the ability to forgive the debt. One solution to lowering the interest and principal over time can be through using the annual exclusion gift amount. The loan can also be forgivable at death, where the remaining balance is paid back by reducing an eventual inheritance.

Before entering into an intra-family loan, consult with legal counsel to draft the terms of the promissory note. Note that the lender will need to report interest payments received as taxable income. Simple to create, the intra-family loan can be a powerful financial strategy in your home-buying journey.

Securities-backed line of credit

When analyzing the amount of personal funds to raise towards your down payment, you can also consider borrowing against your personal investments.

Banks such as BBH provide a securities-backed line of credit (SBLOC) to borrow funds against your qualified investments at a competitive floating rate of interest. An SBLOC requires you to make monthly, interest-only payments. The interest rate is comprised of a fee rate to borrow funds as well as the Secured Overnight Financial Rate (SOFR) published by the New York Federal Reserve, where SOFR is adjusted monthly.

The credit line can be drawn down at any time, as well as paid back partially or in full without penalty. This makes an SBLOC a flexible option for both short and long-term financing.

Trust distributions

In the event your family has created an irrevocable trust for your benefit, the trust’s provisions may allow you to make distributions towards the purchase of your home or the home can be owned outright by the trust itself.

Certain trusts allow for assets to be distributed with a Health, Education, Maintenance, and Support (HEMS) provision. The trustee will determine what qualifies for one of these provisions.

Trusts can also purchase the house and hold the property as an asset for the benefit of the beneficiary. The trustee will need to consider variable costs like taxes, insurance, and maintenance of the property. The beneficiary can enter into a lease agreement with the trust to provide adequate capital to cover and be responsible for ongoing house expenses.

Careful consideration must be made before exploring the use of an irrevocable trust for the benefit of the beneficiary. Consult with your legal counsel to explore your trust’s provisions.

Closing costs – The final extravaganza

As the curtains draw near, closing costs take the stage. These costs typically range from 2% to 6% of the home's purchase price and cover various fees and services. It's crucial for first-time homebuyers to be aware of these costs to avoid any surprises at the closing table. Some common closing costs include:

1. Home inspection fees: Before closing the deal, it's common to have your home inspected for any potential issues. The inspection fee covers the cost of this service.
2. Appraisal fees: Lenders often require a professional appraisal to determine the property’s value and ensure the loan requested is comparable to the market price of the property.
3. Loan origination fees: After you select your mortgage plan, there will be fees charged by the lenders for processing your loan application.
4. Title and escrow fees: These fees cover the cost of searching public records to verify the property's ownership history. 
   

Ongoing costs – Bills, budget, and beyond

Once the purchase is complete and the keys to your new property are in hand, you'll continue the journey with a new set of ongoing financial commitments. Some of these include mortgage payments, utility and maintenance costs, homeowners’ association fees, and property taxes. It is recommended to budget around 1% - 4% of the home's value annually for all ongoing expenses and any excess costs as well. These costs commonly include the following.

1. Mortgage payments: This is usually the largest ongoing cost. A common recommendation is to spend no more than 30% of your gross monthly income on housing costs (including the monthly mortgage payment). 
2. Property taxes: These taxes can vary widely by location and have fluctuated tremendously over the past couple of years. These rates can range from 0.2% to 2.5% of the home's value annually. The actual percentage depends on local tax rates and property values.
3. Homeowner’s insurance: In the event of any unexpected perils causing damage to your house from theft/vandalism, natural disasters, or fires, homeowner’s insurance will cover the cost of rebuilding your damaged property. On average, homeowners can expect to pay around 0.25% to 0.5% of the home's value annually.
4. Renovation projects and repairs: A general rule of thumb is to set aside approximately 1-3% of your home’s purchase price annually for ongoing repairs or unexpected renovations. If you foresee larger projects, such as renovating a kitchen or bathroom, you will need to create a larger budget but will likely see an increase in home value once they’re complete.

Bridging the gap

Each situation is unique, and BBH is here to help make the purchase of your first home a reality. By understanding closing costs, evaluating different lenders, and creating a budget for ongoing expenses, homebuyers can progress toward purchasing their dream home with clarity.

Your relationship team can review your personal financial situation to help understand what a realistic goal looks like for you and determine what other financial strategies you might consider in the purchase.

Using an intra-family loan, an SBLOC, or the ability to receive a trust distribution can help bridge the gap between a down payment and how much mortgage to take for the balance of the home’s purchase price.

To learn more about financing your homebuying journey, reach out to the BBH Next Generation team.