February 8, 2019 | Categories: Personal Finance
You’re trying to save 20 percent to put down on your first home, but do you know exactly why you’re striving for that amount as a first-time homebuyer? Though you don’t need to put down that percentage of your home purchase price in order to buy, it does help in two major ways: It saves you money in the long run by shredding off interest and makes you a more attractive loan applicant. And while all that sounds like a great goal, it can feel impossibly to many. And even if you do find ways to save up that money, will you be sacrificing an otherwise fun and fulfilling life?
While 20 percent down may seem like the standard down payment, it’s actually far from that. According to the National Association of Realtors, in the last five years more than 70 percent of first-time home buyers (who didn’t pay all-cash)—and 54 percent of all buyers—made down payments of less than 20 percent.
What’s getting in the way of us hitting this savings goal? According to that same 2017 report, savings barriers varied amongst the age groups. Around 23 percent of respondents ages 36 and younger said that saving for a down payment was the most difficult task in the home buying process, often citing that student loan debt held them back. Respondents also pointed to credit card and car loan debt as stalling factors.
“There are very practical reasons why people say you should aim for 20 percent, but I know as a first-time buyer, that’s a lot of cash upfront,” says Farnoosh Torabi, personal finance journalist, host of the podcast “So Money,” and Chase Slate Financial Education Ambassador. “When you put that money down, your risk assessment goes down in a good way. In other words, you’re not seen as risky of a borrower as someone who has just five percent down.”
Putting down 20 percent means you won’t have to pay private mortgage insurance (PMI) and you’ll also likely get a better interest rate—two things that will give you a lower monthly mortgage payment. Additionally, having more secure financing will often sweeten your bid to help you get the home you want.
If you’re still figuring out how much money you want to put down on a home, here are some helpful factors to consider:
If you’re going to have a mortgage that’s greater than the cost of your current rent, pretend you already have that mortgage payment, suggests Paula Pant, host of the Afford Anything podcast.
Put that “payment” (or the difference between your current rent and your estimated future mortgage) into a savings account. “That will make you imitate the experience of having a bigger mortgage payment, and you can see what that experience feels like in your life,” Pant says. “If after a month or two you think, ‘This is too stressful. The rest of my cash flow is too tight.’ Then, no harm no foul. You’ve just amassed some extra savings,” says Pant. Use that money later for moving and settling in expenses, she advises.
Most non-conforming loans and conventional mortgages with less than a 20 percent down payment will tack on private mortgage insurance (PMI). PMI protects the mortgage company if you default on your loan. PMI typically costs between 0.5 and 1 percent of the entire loan amount annually, according to Investopedia. That means on a $100,000 loan you could be paying $1,000 a year–or $83.33 per month (assuming that 1 percent PMI fee). Double that monthly number if your loan is $200,000, and so on.
Though $83.33 might not sound a lot per month to you right now, you shouldn’t discount how it might affect your expenses in the future. What if you need to take care of a sick family member, while you’re pregnant, and the car needs new tires, or, if you lose your job and the roof starts leaking? “That’s what concerns me about PMI, it’s not the $80 a month,” says Pant. You have to think about how you can afford this monthly payment over the next 15 or 30 years as you weather all kinds of bumps in the road—financially and personally.
“A major purchase and a long-term commitment should not be based on whether or not at this particular snapshot in time you can meet the monthly payments,” Pant says. “The wiser decision-making framework would be if this purchase is something that you can live with for many years and is affordable enough that if major hiccups were to happen in the future.”
Consider working with a financial advisor before you begin searching for a home to get help saving for a down payment and to make sure you’re looking for a home you can afford.
“When my millennial clients come to me and we discuss their ultimate life goals, buying a home is almost always on their wish lists,” says Ziyah Esbenshade, financial advisor at Pell Wealth Partners in New York City. She’ll work with her clients by conducting an in-depth analysis of their income and expenses: “We identify opportunities for them to save for the down payment,” she says. “Once my clients identify the 20 percent down payment as a goal, then we look at their cash flow and we see how much they can save on a monthly basis,” she says. Then they set up a portion of the client’s paycheck to go to an outside account that’s solely for this goal.
The goal might be to save up that money over a three-year period, says Esbenshade. “Once we create their plan, people get really excited about it and when I meet with them a year later, they say, ‘I can’t believe how much money I had saved for this goal and it feels really attainable.’ There’s a sense of pride there,” she says. (Could you make more money freelance writing? Find out how.)
Credit plays a big role in the home buying process. “I would recommend that you take your credit as seriously as your cash readiness,” says Torabi.
If your credit score is less than stellar, the time you take to save for your down payment is a great time to boost it. It will not only guarantee you get a loan, but also that you will save money in the process. “In order to get the lowest possible interest rate, you want to make sure that you have the best credit score,” Esbenshade says. Not sure what score to aim for? Check out what credit score is needed to buy a house.
All of our experts recommended having at least three months’ of expenses saved in your emergency fund for those unexpected occurrences we mentioned earlier. “I know there’s some people who like to push that a little bit further… but three months is a comfortable barometer,” says Pant.
Torabi echoes this, adding that she thinks digitally-savvy millennials would probably have a better chance of bouncing back after a layoff, and that a minimum of three and a maximum of six months’ of living expenses in savings would suffice.
Read the full article on Apartment Therapy.
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