To kick off the busy spring homebuying season, HSH.com is presenting a series of articles entitled "Preparing to Buy." This article is the first in the series and covers saving for your mortgage expenses.
For many, coming up with a down payment is the biggest obstacle to home ownership. Those with low-to-moderate incomes can apply for down payment assistance through various community agencies or charitable groups, and eligible homebuyers have access to USDA or VA home loans. But if you don't qualify for down payment assistance programs or zero-down home loans, you may have to come up with a down payment the old-fashioned way.
How Much Will You Need?
Your down payment, if you finance your purchase with an Federal Housing Administration (FHA) loan, has to be at least 3.5% of the purchase price (as long as your credit score isn't lower than 580). So if you want to purchase a $250,000 home, you need to come up with $8,750. Of course, you can't forget about closing costs. Plan on paying 2%-3% of the purchase price to fund your mortgage, pay your property taxes and insurance and cover your portion of title insurance and escrow fees. That's another $5,000 to $7,500. Finally, it's a good idea to have an emergency fund set aside to cover your house payment for at least two months. Underwriters call this fund your "reserves," and it makes your application a lot more attractive to lenders.
So, you have a purchase price of $250,000, a loan amount of $241,250 and plus an upfront FHA mortgage insurance premium of 2.25%, for a total of $246,678. Using one of HSH.com's mortgage calculators, you can see that at a mortgage rate of 5%, your mortgage payment is $1,324, plus taxes and insurance. If we assume those are $275 a month, you need about $3,200 to cover two month's worth of payments. Even for a 3.5% down FHA home loan, you'd have to save up just under $17,000!
Lower Your Closing Costs
The easiest way to cut this amount down is to get the seller to cover all or some of your closing costs. After all, whether the seller drops the sale price 3% or covers closing costs of 3%, the results are nearly the same to them (the commission is based on the sales price, however, if they cover costs instead of lowering the price, that expense is only slightly bigger). A full-price offer with closing cost concessions may make more sense for a cash-strapped buyer than a reduction in sales price. Keep in mind that the FHA has recently lowered acceptable seller concessions from 6% to 3%.
Let's say you're able to negotiate this 3% concession for closing costs. Now that you've got your goal down to $12,000, you've got to create a plan for saving that sum.
Practice for Home Ownership While Saving Money
If your proposed mortgage payment is $1,324 plus $275 for taxes and insurance, or $1,599 per month, and your rent is $1,000 a month, you know you'll be paying $599 a month more once you buy your home. Can you handle it? Before you buy, see if you are ready to handle the increased expense. Try putting that additional $599 a month into a special account for your home. After a few months, evaluate your success. Have you been able to put all that money aside? Have you been able to avoid increasing your debt (it's not really savings if your credit card balances go up too)? Have you been able to keep your hands off that account? If not, you may need to choose a cheaper house with a lower monthly payment, but it's better to find that out now. Assuming that you can save the $599 a month, and if you can earn 2% interest on your savings, it will take you 20 months to save $12,192.
This plan accomplishes three things:
- You save money toward your down payment.
- You get to test-drive your proposed mortgage payment to see how comfortable you are with the added expense.
- If you don't have an extensive credit history, underwriters are allowed to consider regular additions to a savings account as a monthly obligation that you have honored successfully. Doing so makes your credit look better.
Speed it Up
Can you speed up that timetable? Maybe. Selling some of your belongings at a garage sale or through EBay or Craigslist can generate some revenue. You'll probably want new furniture when you get your new house anyway, so sell what you don't need now to make that day come sooner -- plus there will be less stuff to move! Are you a couple owning two cars? Try selling one and carpooling for a year. Put the proceeds or the saved car payment funds toward your down payment. Eat at home more, spend more time at the gym and less time out on the town -- figure out what your biggest money-drains are and which ones you can cut out or change.
Start your plan now. In the next year or so, you can establish great savings habits, enhance your credit rating and enjoy the satisfaction of achieving a worthy goal: your first home.
Gina Pogol has been writing about mortgage and finance since 1994. In addition to a decade in mortgage lending, she has worked as a business credit systems consultant for Experian and as an accountant for Deloitte.