Pros and cons of down payment assistance options

You know it's in your best interest to put down 20 percent on the home you want to buy. If you can scrape together that kind of down payment, you'll wind up with a loan on the best terms, without paying private mortgage insurance (PMI) or the FHA equivalent of PMI, also known as MI, or a higher monthly interest rate.
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But even as housing prices moderate somewhat in various areas, coming up with that kind of cash is tough. Most first-time buyers don't have 20 percent to put down on a home. They're looking to put down just 3 to 10 percent in cash.

While getting a 100 percent loan (no down payment necessary) is still possible, it's tough to find a good lender who will do it at a reasonable cost. So, scraping together as much of a down payment as possible is important.

In addition to saving every cent you can for 3 to 4 years, there are a few possible sources for down payment assistance. I've outlined the positives and negatives associated with each option:

Borrowing from a 401(k). If you work for a company that offers a 401(k) plan, it's in your best interest to fund it to the maximum allowed for your income. Not only will you be able to tap into the power of compounding (and have your money work harder for you), but you'll be able to more quickly build a sizeable nest egg for your retirement. When it comes to borrowing from a 401(k) plan, not every company allows it. Check with your plan administrator to see if your company will allow you to borrow, if there are limitations on what you can do with the cash, and what the interest rate will be on the money you borrow. You should also be aware that you'll typically need to repay this cash within 5 years. But if you should leave the company, or be fired, you'll need to repay the cash within 60 days, or it will be considered a withdrawal (and you'll owe federal income taxes on that money along with a 10 percent penalty, if you're under the age of 59 1/2).

Withdrawing up to $10,000 from an IRA. If you have an individual retirement account (IRA), the IRS allows you to withdraw up to $10,000 for the purchase of a first home. (For those of you who have purchased a home before but haven't owned a home in the last 3 years, you're considered to be a "first-time buyer" for this specific purpose and can make a withdrawal). When you withdraw cash at any time from a tax-deductible, tax-deferred IRA, you'll owe federal income taxes on the amount you're withdrawing at your current marginal tax rate. However, if you're withdrawing for the purchase of a first house, you will not owe the 10 percent under-age penalty if you're less than 59 1/2 years old.

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source: boston.com