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What's the best down payment on a home?

October 24, 2012: 6:30 AM ET

My wife and I are contemplating home purchases, and we're trying to determine the best course of down payment: Ten percent down and pay private mortgage insurance? Twenty percent down with the help of a 10% family loan? (And would that affect our mortgage?) Or 10% borrowed from a 401(k) to make it 20% down? Which one costs us the least in the end? — Mike, New York City

There are pros and cons to all of these options, but the best choice is probably a family loan or gift that will boost you to a 20% down payment. You'll avoid private mortgage insurance, which is an added fee you pay when you borrow more than 80% of a home's value. "PMI is more expensive now than it has historically been, and it's difficult to have it lifted," says Gloria Shulman, a mortgage broker in Beverly Hills and founder of Centek Capital Group. In order to have PMI removed from your mortgage, you have to pay down your loan to 78% of your home's value, as judged by an appraisal, which isn't always so easy.

A gift is better than a loan because a family loan will be counted against you in terms of debt load, which may make it more difficult to qualify for your mortgage. If it's a gift, it doesn't. All gifts must be documented, by the way. "You have to show the source of the gift," Shulman says. "For example, your parents' accounts."

Of course, if it's a loan, it also has to be on the books, with a term of at least five years and a payment schedule. Your family member must also charge a minimum amount of interest to keep it from being a gift, according to the IRS. Currently, that rate is pretty low, though. As of November, it was 0.89% annually for a loan with a term of up to nine years. (For the full current rate schedule, go to http://apps.irs.gov/app/picklist/list/federalRates.html.)

A 401(k) loan is a trickier source. First, you have to make sure it's possible; not all 401(k) accounts allow it. Second, you can typically borrow up to $50,000, but if you lose your job before you've paid it off, you'll owe the full balance back within 30 to 90 days. If you can't come up with the cash, it will be considered a withdrawal, with all the taxes and penalties that come with it.

— Kate Ashford

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