This loan is not available to everyone and there are restrictions, but there are plenty of borrowers out there for whom this can be a great fit. The USDA Guarantee Rural Housing program is available to homebuyers purchasing a home in a rural area. The area must be defined as rural by USDA Rural Development and eligible properties cannot produce income (so no investment properties allowed). To determine if a property is within an approved area the USDA website has tools to help you identify them. So, if you have a property in mind, go ahead and enter it in and see if the property is located in an eligible area.

There are many advantages to the program. Such as:

1. 100% financing for first-time and repeating homebuyers.
2. No limit on seller contributions of gift funds from acceptable family, friends or non-profit organization.
3. No Maximum loan amount.
4. 30 year Fixed Rate.
5. No monthly mortgage insurance.
6. No reserve requirement (you do not need to show you have sufficient money to cover a mortgage payment for 2-3 months)

Keep in mind that even if you do meet the property requirement there are other requirements specific to your situation. So for borrowers to qualify they must be purchasing a primary residence, not own any other real estate and must meet income limitation requirements. Additionally, income from all household members over the age of 18 must be counted in household income. This household income may not exceed the moderate income levels set by the USDA for the area. Again the USDA website has the details to see if you meet this income limitation.

The USDA Guarantee Rural Housing program has become to mortgage of choice for most borrowers who qualify for the program and want to put a minimal amount down. Arizona homebuyers purchasing a home in the towns of Maricopa, Buckeye, Queen Creek and many other communities will find this mortgage to be a very attractive option.

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Heather Barr over at The Phoenix Agent blog has a great blog post detailing all aspects of this provision. For one thing you can use the $8,000 to cover closing costs, include additional cash down payment and any mortgage interest rate buy-down costs. Notice you can’t use these funds to cover the required 3.5% down payment. Read Heather’s post for additional details.

Here is a portion of the HUD announcement for those interested:

WASHINGTON – Speaking to the National Association of Home Builders Spring Board of Directors Meeting, U.S. Housing and Urban Development Secretary Shaun Donovan today announced that the Federal Housing Administration (FHA) will allow homebuyers to apply the Obama Administration’s new $8,000 first-time homebuyer tax credit toward the purchase costs of a FHA-insured home. Donovan said that today’s action will help stabilize the nation’s housing market by stimulating home sales across the country.

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You have pre-paid interest as part of your closing costs at the close of escrow. This is essentially your daily interest rated times the number of days remaining in the month. So, if you close in the 16th of the month (in a month with 30 days), you would have 15 days of interest due at the end of that month. Instead of asking you to make a payment that month, lenders will just ask you to pay upfront at close. This results in your first mortgage payment being due the 1st of the following month. So, if you closed on September 16th, your first payment would be due November 1st.

However, there is a feature called interest credit – where if you close within the first seven days (varies from lender to lender), instead of charging pre-paid interest the lender will give you an interest credit back for the number of days in the month. So, if you closed on the 4th – you would get four days of interest credit back at close. This of course results in you having to make your first mortgage payment at the end of the month. So, if you closed on September 4th and you received four days interest credit, your first payment would be due October 1st. A whole month earlier than in the prior example.

Be aware that you do have a choice on whether or not to accept an interest credit – but you need to mention this to the bank. Either way you’re paying – whether it is at close or in the form of a mortgage payment, but you need to be prepared. Purchasing a home entails lots of charges, so its easy to run into a cash flow problem if you are closing at the beginning of the month and your first payment is in a few weeks. The first payment is not one you want to miss – not that you want to miss any payment at all.

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I certainly can understand the temptation to use money from a 401(k) plan for a home purchase or even using it for emergency purposes. This is especially tempting if you have a decent amount of money in your account and you have recently faced some difficulties. However, I suggest taking a long hard look at this before deciding on a withdrawal. To help in this, MSN Money Central has a good article on this subject which outlines the pro’s and con’s of borrowing against a 401(k) plan:

The pros:

1. There is no credit check.
2. There is a low interest rate.
3. It provides a great return.
4. The interest is tax-sheltered.
5. It’s convenient.

The cons:

1. About that credit check: Of course there isn’t one. You’re not borrowing anything. You’re spending your own money.
2. You’re losing interest. The net effect is that you have less money to invest and to earn interest.
3. It’s not tax-sheltered money anymore. Whether you repay the 401(k) loan out of your salary or from a bank account, those payments are all made back into the 401(k) with after-tax dollars.
4. Unless you repay the loan, it is considered a premature distribution. You would owe federal and state income taxes as well as that 10% penalty if you are under age 59 1/2.
5. The loan isn’t tax deductible. It’s considered a consumer loan, so there is no tax advantage.
6. It affects your psychology toward retirement saving.

While it is up to an individual to decide if they want to make a withdrawal on their 401(k) I personally would not recommend this course of action – certainly not for a home purchase. My main concern is point #6: your psychology towards saving for retirement. I think the moment you tap into your 401(k) it’s easier to do that again and again. Then it just becomes another savings account (very expensive one), but you destroy your ability to save!

The main reason to not borrow is because there are still so many loan options available to purchase a home. FHA allows you to borrow up to 97% of the home value and allows 3% gifts. So, in essence you can do a 100% loan with little out of pocket money. The FHA loan limits have been recently increased and in many markets this limit is well above the median home price. So it’s not like you can only buy the bottom of the barrel homes with FHA. You can actually buy your dream home.

The better option is therefore for you to work with a mortgage loan professional and make a six or twelve month plan to reposition your credit, income, savings and investments. This effort on your part can help you purchase a home without touching your 401(k). Home prices are not increasing at astronomical levels – so there is no reason why you shouldn’t wait until you’re much better positioned to make a sound purchase. That way you’ll have a home and something for retirement – not just a home.

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I must caution you that the closing cost numbers presented are for a very modest purchase. You must read the disclaimer below the chart. In order to do an apples to apples comparison, the researches compared costs for a $200,000 purchase putting 20% down. So, a $160,000 loan size. Also, they only looked at borrowers with excellent credit. Be aware that higher loan amounts will have higher closing costs since items such as origination points, title insurance etc. are based on a percentage of the loan amount.

Still, I think we’re doing a pretty good job here in Arizona and keeping costs as low as possible for the consumer. Congrats to all those involved.

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