Tom Lee ABR CRS GRI LTG SRES's Blog
Buying a home is a big financial endeavor that takes planning and saving. Aside from a down payment, hopeful homeowners will also need to save for closing costs and moving expenses.
When it comes to the down payment amount you’ll need to save, many of us have often heard 20%, the magic number. However, there are a number of different types of mortgages that have different down payment requirements.
To complicate matters, mortgages vary somewhat between lenders and can change over time, with the ebb and flow of the housing market.
So, the best way to approach the process of saving for a down payment is to think about your needs in a home, and reach out to lenders to start comparing rates.
However, there are a few constants when it comes to down payments that are worth considering when shopping for a mortgage.
In today’s post, we’re going to talk about some characteristics of down payments, discuss where the 20% number comes from, and give you some tips on finding the best mortgage for you.
Do I need 20% saved for a down payment?
With the median home prices in America sitting around $200,000 and many areas averaging much higher, it may seem like 20% is an unattainable savings goal.
The good news is that many Americans hoping to buy their first home have several options that don’t involve savings $40,000 or more.
So, where does that number come from?
Most mortgage lenders will want to be sure that lending to would be a smart investment. In other words, they want to know that they’ll earn back the amount they lend you plus interest. They determine how risky it is to lend to you by considering a number of factors.
First and foremost is your credit score. Lenders want to see that you’re paying your bills on time and aren’t overwhelmed by debt. Second, they will ask you for verification of your income to determine how much you can realistically hope to pay each month. And, finally, they’ll consider the amount you’re putting down.
If you have less than 20% of the mortgage amount saved for your down payment, you’ll have to pay for private mortgage insurance (PMI). This is an extra fee must be paid in addition to your interest each month.
First-time buyers rarely put 20% or more down
Thanks to FHA loans guaranteed by the federal government, as well as other loan assistance programs like USDA loans and mortgages insured by the Department of Veterans Affairs, buying a home is usually within reach even if you don’t have several thousands saved.
On average, first-time buyers put closer to 6% down on their mortgage. However, they will have to pay PMI until they’ve paid off 20% of their home.
So, if you’re hoping to buy a home in the near future, saving should be a priority. But, don’t worry too much if you don’t think you can save the full 20% in advance.
For many of us, it can seem like our paychecks are gone before we even get a chance to see them. With seemingly endless bills and expenses, both recurring and unforeseen, saving up for a house is a daunting task.
Fortunately, there are ways you can prepare yourself for those intimidating down payments and many closing costs.
In this article, we’re going to walk you through how you can start saving for a home right this moment. After all, every day is another day you could be contributing to your savings and taking another step closer to owning your own home.
Use a Budgeting Tool
The first step to saving and determining how much you can save is to start budgeting. Many people hear the term “budget” and get nervous thinking they’ll have to start counting the number of coffees they buy. However, there are less anxiety-inducing ways to budget.
From your phone, tablet, or computer you have access to a large number of free budgeting tools. Mint, You Need a Budget (YNAB), and PocketGuard are three of the top budgeting tools that will get you started.
With apps that integrate with your bank accounts and loan balances, there is little work required on your part. Just set an amount to save each week or month, and direct the funds into your savings account.
Set up a dedicated savings account
Speaking of savings accounts--now is a great time to set up a new one. It’s almost always free to open a new account with your bank. What’s more, it’s a lot less tempting to pull from a savings account when it’s labeled something like “HOUSE SAVINGS - DO NOT TOUCH.”
Once you have your budgeting app and bank account set up, it’s time to dig into some of the ways you can save money without skipping meals.
Cutting Monthly Expenses
Rather than telling yourself you can’t buy any more fancy Starbucks drinks anymore until you have a house (don’t torture yourself), make a list of all your monthly expenses. That can include anything from Netflix and Spotify to haircuts and car washes.
A great way to make this list is to go through your credit and debit card transactions. If you have autopay set up, you might not even realize how many services are withdrawing directly from your accounts each month.
For each item on your list, determine if you can either eliminate the expense or spend less on it. Maybe you go for the deluxe car war rather than the basic. Or, you might pay for services you don’t use as much as you used to.
If you’re worried about having no entertainment if you drop Hulu, Netflix, and Amazon Prime, you could try out your local library system. Most of the time you can have books, movies, and music shipped for free from all around your state.
When it comes to cable, cell phone plans, car insurance, and other monthly bills give your provider a call and tell them you’re thinking about switching over to a cheaper competitor. They’ll likely offer you a discounted rate. If they don’t, follow through on your promise and call other providers to see if you can get better rates.
You're on the right track if you've started saving for your mortgage down payment. It could take you several years to save the size of down payment that shaves $200 or more a month off your monthly mortgage premiums. Between now and the time that you save a good down payment, a lot could happen.
Just what does go into those early mortgage payments?
Economic shifts could find you moving to another job. Other changes that just might happen before you finish saving your down payment range from meeting your future spouse, having another child or needing to move an aging parent in so that you can take care of her.
But, you could be fortunate and not have to deal with a lot of personal or work related life shifts. You still might have to adjust after you understand the different costs that go into early mortgage payments. For instance, after you find the house that you want to take a loan out for, you will generally have to pay:
- Closing costs (this expense generally runs between two to five percent of the cost of your house)
- Points (the more points you pay, the lower your monthly mortgage premiums generally are)
- Title search and title application fees
- Home appraisal fees
- Home inspection fees
- Mortgage application fees
- Realtor commissions and fees
- Loan origination fee
- Credit report fee
- Down payment
- Mortgage insurance premiums
Seek help that has nothing to do with a mortgage lender
Depending on where you buy your house, you might also have to pay the first month's homeowner's association fee. A healthy mortgage down payment can keep you from having to pay mortgage insurance. Check with your realtor and the lender that you go with when you buy your house. If you can't avoid paying for mortgage insurance, at least work to get the lowest insurance possible.
After all, you have shown the lender that you're a responsible borrower. You did that when you took the time, perhaps years, to save for a strong mortgage down payment.
Regarding a healthy mortgage down payment, target saving 20% of the total cost of the house you're looking to buy for your down payment. This 20% is in addition to other costs, such as those listed above, that you will put toward owning a house.
If you want to add a financial cushion to the home ownership process, consider saving the first two to three months of your mortgage. Keep this money in the bank in the event that you experience a life shift that ties up a portion of your income for a few weeks.
Make the saving process easy on yourself by holding all adults who live in your house responsible for contributing a portion of their income to the mortgage down payment and the monthly mortgage premiums. Owning, maintaining and paying for a house is not the time to be a hero. The more people you have helping you to pay and care for the house, the better.
Your 401K is a great resource of investing for retirement. Many people use their 401k’s as a part of their overall investment strategies, pulling money out of it when it’s needed. When you’re ready to buy a house, you may think that pulling money out of your 401k for a down payment is a good idea. But think again.
Although you should always speak with a financial professional about your money matters, the bottom line is that is probably not the best idea to use your 401k to supply money for a downpayment on a home.
First, your 401k funds are pre-tax dollars. That means that you haven’t paid any taxes on these funds. Your employer will often match the amount of money that you put into your 401k, as an incentive to help you save money for your future. You need to keep your 401k for a certain amount of time before any funds in the 401k become available to you without having to pay any kind of penalty. If you decide to take on the penalty, you can often face a cut to your employer’s match programs as well. This is why you must make this decision wisely.
Anyone under the age of 59.5 pays a penalty of 10 percent to take the money out of the fund. In addition, you’ll now need to pay taxes on this money, because it becomes a part of your adjusted gross income.
If you are looking to invest in a property, there may be other options for you rather than pulling money out of your 401k. While some plans allow you to borrow money from it. However, if your only option to get money to invest in a property is to pull money from your retirement account, it may not be the best time to invest in property for you.
Keep It Separate
If you’re younger (say in your 30’s or 40’s) your best option is to have a completely separate account that is used to save for a downpayment and other expenses that you’ll incur when you buy a home. In this sense you aren’t spreading yourself too thin as far as investments go. You should compartmentalize your money. Buying a home is a large investment in itself. Home equity can also be a good source of a nest egg in later years when you need it. However, even if a property will be an income property, it’s never smart to take from one investment account to provide for another unless you’re shifting your focus. You don’t want to reach retirement, only to see that your funds have been depleted and you can’t retire as expected.