Episode 299: January 22, 2013
by Laura Adams
A Money Girl reader named Monica C. asks:
“I want to buy a house in a few years. What’s the best way to start saving for the down payment and what type of account should I use?
Most people would love to own a home or vacation property of their own, but they don’t have enough for a hefty down payment. In this 2-part series, I’ll tell you how much money you need for a down payment, where to put it, and how to save as quickly as possible to buy the home of your dreams.
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What Is a Down Payment?
When you get a mortgage to buy a home, lenders require that you make an upfront investment, which is called a down payment. A typical down payment ranges from 5% to 20% of the purchase price.
For instance, let’s say you find a great place and negotiate with the seller to buy their home for $300,000. If a lender approves you for a loan with 10% down, you’d have to pay $30,000 ($300,000 x 10%) plus additional closing costs, out of pocket and borrow the balance of $270,000.
How Much Down Payment Should You Save?
So, the amount of down payment money you need to save depends on 2 factors: the purchase price of the home you buy and the percentage required by the lender to pay upfront. The larger your down payment, the smaller your mortgage and monthly payments will be.
A huge benefit of paying at least 20% down is that you don’t have to pay private mortgage insurance (PMI). This is an additional monthly expense you must pay which protects the lender in case you default or don’t make payments as agreed. However, you can cancel PMI if you pay down your mortgage so you have at least 20% equity in your home.
For these reasons, paying 20% down is the gold standard. But for many people, coming up with that much money is about as easy as running an ultra marathon in the desert. My advice is not to let the 20% rule keep you from becoming a homeowner if you find an affordable property that will be a good long-term investment.
How Much Home Can You Afford?
Don’t let the 20% rule keep you from becoming a homeowner if you find an affordable property that will be a good long-term investment.
As you start planning to buy a home, begin with the end in mind. Be realistic about the average home prices where you want to live.
Research home listings online at realtor.com or speak with a local real estate professional. Then contact several lenders to ask about their mortgage requirements so you’ll know what to expect when the time is right to make a purchase offer.
How much home you can afford depends on several factors, such as your income and expenses, credit rating, down payment, and the going interest rate for mortgages. A common rule of thumb is that your monthly housing expense shouldn’t exceed 25% to 28% of your gross income.
Also, consider how becoming a homeowner fits into your overall financial goals, such as saving for retirement or a child’s education. Never buy a home if the monthly payments would leave you strapped and unable to provide for your financial future.
How to Get Down Payment Assistance
If you’re a first-time home buyer, a veteran, have low income, or want to buy property in a rural area, it’s possible to qualify for down payment assistance through the following programs:
The benefits of down payment assistance programs vary depending on their rules and your circumstances—but they offer low or no down payment so it’s easier to become a homeowner.
But if you aren’t eligible for assistance, you’ll need to accumulate some serious savings to qualify for a mortgage. In part 2 of this series, we’ll cover strategies for saving down payment money and the best places to keep it until you’re ready to buy a home.
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