As I steadily venture into new territory of debt free life, I must admit that my confidence is beginning to wane. It’s sort of like being the new kid in school. I have no idea what to expect, and I’m fearful of the unknown. But most importantly, I’m afraid of screwing up.
I can’t avoid making mistakes in life, but I can make cautious decisions. There has been lots of news about foreclosures and unconventional loans, which I plan to avoid. To be safe, I’m going the traditional route by saving for 10% down payment on a house and obtain a 30 year fixed-rate mortgage. (If I were single, I’d be shooting for 20% down payment.)
Originally I thought saving for a down payment would be a daunting and downright impossible achievement. The process is actually not going to be that bad. I got most of the hard work out of the way by nearly eliminating credit card debt and establishing a strong credit score. The task now involves some homework and persistence.
Here are some recommendations I liked from some trustworthy sources.
Nearly every source of information will remind you that a home is the most important purchase you’ll make in life. Thus, it’s best not to chase the American Dream carelessly.
Former president of the National Association of Realtors, Tom Stevens, tells MSNBC that first time homebuyers should, “Think about your plan for the next year, five years, even 10 years. Look at what you hope to accomplish professionally, personally, as a couple and as a family and what kind of home and neighborhood will best serve those plans.” This idea ties in nicely with point #2.
2. Don’t Shoot for Your Dream Home the First Time Around
Realtor James Raysbrook further adds, “This is a move-up process. [First time homebuyers] should not expect to buy into Mom and Dad’s neighborhood first time out… even if they end up out in the suburbs accepting a commute for a few years, their home will appreciate with the rest of the area along with their incomes. This will allow them, in time, to trade up until they live exactly how and where they want.”
I’m not thrilled about the idea of settling for a house in the suburbs, but I’d rather choose financial stability over a more hip address. However, it’s important that I strike a compromise between a starter home and a place I’ll be happy with for several years. Bankrate.com warns, “Closing costs and other home-buying fees, as well as the commission that most owners end up paying to real estate agents when they sell their homes, add up. People who have to sell after living in one place for only a short time can end up in the hole on their investments.”
3. Figure Out How Much House You Can Afford
Bankrate.com also explains that for mortgage lenders “to determine if you qualify for a loan, they will consider your credit history, your monthly gross income and how much cash you’ll be able to accumulate for a down payment. So how much house can you afford? To know that, you need to understand a concept called ‘debt-to-income ratios.'”
You want to know your front-end ratio, which “shows how much of your gross (pretax) monthly income would go toward the mortgage payment. As a general guideline, your monthly mortgage payment, including principal, interest, real estate taxes and homeowners insurance, should not exceed 28 percent of your gross monthly income.”
And you need to know your back-end ratio, which “shows how much of your gross income would go toward all of your debt obligations, including mortgage, car loans, child support and alimony, credit card bills, student loans and condominium fees. In general, your total monthly debt obligation should not exceed 36 percent of your gross income.”
Gathering this information helps you to input numbers into the following calculator to determine exactly how much house you can afford. Some footwork is required, like figuring out taxes and home insurance rates in your desired home area. Some guesswork is also required if you don’t have down payment money saved, like me. But there’s an opportunity for a great lesson by playing around with down payment values. You’ll find that the more down payment money you have, the less your monthly mortgage payments.
4. Determine a Down Payment Value and Sources of Money
The task of figuring out how much money to save for a down payment can be made easier if you figure out how soon you want to buy a house; how much risk you’re willing to take; and how much cost you’re willing to incur with a lower down payment.
Holden Lewis at Bankrate.com explains, “There are myriad ways to leap the down-payment hurdle. Some strategies are for people who have some money saved up somewhere, and other strategies are for people who are practically broke.
“It has been a long time since home buyers were required to come up with 20 percent down. Some lenders will lend 100 percent of the purchase price or even 103 percent. More commonly, lenders underwrite mortgages with 3 percent or 5 percent down. The question becomes: How do you come up with that 3 to 5 percent?”
If you’re one of the 22% of people whose down payment came from a friend or relative last year, great! That may be an option for some lucky folks, but not for me. Other options include borrowing from your retirement funds like your 401(K), but be warned that you can incur tax penalties if you lose or switch jobs. You can also see if you qualify for a HUD special housing program. Yahoo! Finance also recommends that “if you are buying in an urban area or have low to moderate income, look into programs offered by your city or state that provide below-market loans with little or no down payment required. If you’re really cash-strapped, you can get 100% financing by ‘piggy-backing’ a second loan equal to 20% of the purchase price on top of your 80% loan. But that 20% second mortgage will come at a much higher rate.”
My personal choice was to come up with a savings goal ($30,000 in five years), and each month put $500 into a high-yield savings account to reach that goal. By going the slow and steady route, I feel much better about accumulating money while still weathering an uncertain period of my life. I’m not sure where I’ll end up in five years, or how much money I’ll be making by then. The good thing about taking my time to save is that I might be in a position to put away more money as my income increases, and thereby be able to afford more of a house.
There’s not one right answer for how to save for a down payment, but I’ve learned reverse engineering is a good strategy. Think about your dream house. How are you going to get there? Maybe a starter house for a good number of years? But how are you going to get in that starter house? Perhaps get some help from family or a housing program? Special financing options? Or will slow and steady best suit your needs? By answering these questions and taking the next possible action, saving for a down payment isn’t as dreadful as it seems.