How To Save For A House

SUMMARY

Saving for a new home can seem like an insurmountable challenge, especially for first-time buyers. But what kind of numbers really come into play? We look at down payments, mortgage insurance, closing costs, and more.

Singles, couples, families, at some point almost everyone turns their financial attention to buying a home. But how much do they really need to save, the first time out? How much is enough to handle the typically steep curve of down payments and closing costs?

When it comes to saving for a home, there are some helpful rules of thumb. But then, there are also alternatives for buyers who need a leg up. Let’s look at the basics, and some workarounds, considering approaches that first-time buyers can take to getting through the front door of their first house.

Buying Your New Home: Savings and Expectations

Most real-estate experts will tell you to have at least 5% of the cost of a house on hand in savings to account for the down payment. But that’s only a minimum, and expectations can differ by community.

In a city like New York, for example, minimum down payments are almost always 20%, no less. And even if you’re able to secure a mortgage by putting down less than 20% of the selling price, you’re almost certainly triggering mandatory mortgage insurance as a consequence. Mortgage insurance, however, doesn’t have to be a major stumbling block.

  • Mortgage Insurance Terms:

    In general, homebuyers who pay less than 20% in their down payment have to pay mortgage insurance until their loan-to-value ratio is 80% . So, if you borrowed $270,000 on a $300,000 home ? in other words, your down payment came to 10% ? your LTV would be 90% (that is, the loan amount, $270,000, divided by the price of the house, $300,000). Your monthly payments on that policy would continue until you paid your mortgage down by another $30,000, to a balance of $240,000 ? or, 80% of the full price.

  • Mortgage Insurance Premiums

    The amount of your mortgage-insurance premium depends on your credit score and the size of your down payment. In many cases, when it comes to private loans, mortgage insurance runs in the 0.3%?1.15% range . In our previous example, your monthly insurance payment would be some $68?$259.

And so, on a 30-year mortgage, our homebuyer, given an excellent credit profile, would take on approximately $1,762 in monthly payments (at a 5% interest rate, including 78 mortgage-insurance payments of about $113 at 0.5%, and blending property tax into the payments at 1.25%). That’s based on an initial savings of $30,000, used as a down payment on a $300,000 house.

Note, if our homebuyers had saved $60,000 for the down payment, their monthly bill would drop to some $1,600, eliminating the need for mortgage insurance. However, in our model, mortgage insurance accounts for just $1,356 annually over 6.5 years in the $60,000-down-payment case ? or $8,800 total. Turns out that’s a lot less than saving the additional $30,000 to hit the 20% down-payment mark. And so, if savings are an issue, first-time buyers might take on the insurance in exchange for a lower down payment.

Closing Costs: First-Time Buyers Beware

Closing costs typically include fees for commissions, appraisals and surveying; inspections and certifications; tax and title services, government record changes, and transfer taxes. You’ll also pay an origination fee to your mortgage lender, and a charge for specific interest rates.

Other factors can also come into play. In a major city co-op, you may be required to have a year or more of maintenance fees in the bank. And, finally, remember the tail end of every home buyers’ experience is the move ? meaning, more bills as well.

First-time homebuyers are sometimes surprised when they see how closing costs can add up. The average amount can come to some 3% of the price of the home, and run all the way up to 6% . Given that range, it’s a wise idea to start with 2%?2.5% of the total cost of the house, in savings, to account for closing costs. Thus, our $300,000 first-time homebuyer should sock away about $6,000?$7,500 to cover the back-end of their buying experience. Tallying the savings we’re talking in total, so far, the amount comes to $36,000?$37,500.

And, don’t leave out one all important consideration: the homebuyer’s buffer.

To your initial savings for a $300,000 home, it’s also wise to tuck aside enough to ensure that any unexpected twists and turns are accounted for after you move into your new house. A sensible goal is to think of that buffer as a half-year of mortgage payments. That would be $10,572 for the buyers in our initial $300,000-at-10% model ? a total of $46,572?$48,072 in the bank before closing a deal.

Home-Buyer Alternatives for First Timers

If saving for a first home seems a hill too steep, take heart. Assistance programs can help. Starting with plans at the federal level, these can cut the initial savings needed by a dramatic amount.

  • FHA Loan

    Depending on property location and other, personal factors, you could qualify for a home loan from the Federal Housing Administration. In most cases, you’d be expected to make a down payment of approximately 3.5% (with a 1.75% insurance premium, and at a 4.25% interest rate). A down payment on our $300,000 model: $10,500. Together with closing costs and a buffer, savings required would be $26,916?$28,416. Notice, however, that you’re paying a great deal more than in the non-FHA model when it come to the higher mortgage-insurance premiums? some $43,485 over 103 months. Still, the FHA plan may be more manageable for some, as the initial down payment is smaller and insurance payments are spread out.

  • VA and USDA Loans:

    Certain veterans, active members of the military, and qualifying residents of designated rural areas can qualify for a 0% down-payment housing loan ? mortgage-insurance free as well ? from the Veterans Administration or the U.S. Department of Agriculture. In this case, first-time homebuyers could walk into a $300,000 house for just the closing costs, plus the suggested six-month buffer.

What’s clear is that homebuyers have options, and while the savings required to get a first home can total in the mid five figures, they can also come in around the mid-twenties. There are also assistance plans available from Fannie Mae and Freddie Mac, featuring 35% down payments, and each come with their own pros and cons. First-time homebuyers should also look into state and local plans. The research you invest in your process ahead of time can greatly affect what you have to save up before turning the key to your new front door.

Video

Government-Insured Loans

FHA loans (3.5% down)

You can put as little as 3.5% down on FHA loans if you have a minimum credit score of 580. FHA-approved lenders also will consider borrowers with non-traditional credit histories as long as you’ve had on-time rent payments in the past 12 months, no more than one 30-day late payment to other creditors, and you haven’t had any collection actions (medical bills being the exception) filed in the last 12 months. 

Also, the property you’re buying must comply with the property standards set by the U.S. Department of Housing and Urban Development for single-family and condo homes and be within FHA loan limits. Another benefit of FHA loans is that you can use a financial gift from a relative or friend toward all or part of your down payment if you provide documentation stating it’s a gift and not a third-party loan.

VA loans (0% down)

U.S. military service personnel, veterans, and their families can qualify for zero-down loans backed by the U.S. Department of Veteran Affairs. Other benefits include a cap on closing costs (which may be paid by the seller), no broker fees, and no MIP. VA loans do require a “funding fee,” a percentage of the loan amount that helps offset the cost to taxpayers. The funding fee varies depending on your military service category and loan amount.

USDA loans (0% down)

The U.S. Department of Agriculture guarantees loans to help make homeownership possible for low-income buyers in rural areas nationwide. These loans require no money down for qualified borrowers—as long as properties meet the USDA’s eligibility rules.

Related Resources

Viewing 1 – 3 of 3

Earnest Money: What Is It And How Much Is Enough? Mortgage Basics – 7-minute read Patrick Chism – May 25, 2022 Earnest money protects buyers and sellers in a real estate transaction. Learn how an earnest money deposit works and how it can also make your offer stand out. Read More

How To Get A Mortgage: A Step-By-Step Guide Mortgage Basics – 8-minute read Victoria Araj – June 03, 2022 Wondering how to get a mortgage? Our easy-to-follow guide will walk you through what lenders are looking for, the documents you’ll need and more. Read More

How To Buy A House With No Money Down Home Buying – 7-minute read Victoria Araj – June 09, 2022 Worried about coming up with a down payment for a home? Did you know that you can buy a house with no money down? Here’s how to do it. Read More

Down Payment

When you buy a home, your down payment is the amount of your own money you contribute toward the purchase price. The remaining amount becomes your loan size.

Statistically, first-time home buyers make smaller down payments than the general home-buying population.

Among all home buyers, the average down payment is 12 percent. Active duty servicemen and servicewomen average 4 percent. First-time home buyers average 7 percent. There is no rule for how much money you should put down.

Some home buyers use down payment assistance (DPA) programs as part of their purchase.

Down payment assistance programs offer low- or no-interest loans of up to $100,000, or forgivable loans and grants to eligible first-time buyers. Many buyers combine the mortgage loan with a DPA to make a 100 percent mortgage

The best down payment is the one that makes you comfortable, and leaves you with cash in your bank account to access in an emergency.

Typical closing costs (other than origination fees and discount points)

Below is a list of common closing costs, including their purpose and a general cost range. Not all will be charged in every case, and there may be additional fees specific to your geographic location.

  • Application fee – Not all lenders charge this fee, but when they do it usually includes funds for both the appraisal fee and the credit report. It will generally be between $300 and $500 if it is charged.
  • Appraisal fee – This is the fee the lender will pay to an independent appraiser to establish the market value of the property you are purchasing or refinancing. It will generally be between $300 and $500 depending on the property and appraisal fees in your market area.
  • Title search – This is a search done by a title company to determine the existence of any liens against the property. It’s to ensure the property will transfer with a clear title. The cost of the search is typically between $200 and $300.
  • Title insurance – This insurance is purchased to cover any liens that may not have come out during the title search. You’ll be required to have lender’s title insurance to protect the lender against any undiscovered liens. But it’s strongly recommended that you also get owner’s title insurance as well, which will protect you if such liens are discovered. With owner’s title, you’ll be able to refinance your home or sell the property even if a prior lien is discovered. The cost of lender’s title insurance is usually several hundred dollars, and is based on the value of the home. Owner’s title is usually around $200.
  • Attorney fees – In many states, real estate closings are handled by title companies. But in others, they’re customarily handled by attorneys. Expect to pay between $400 and $1,000 or more depending on the complexity of your transaction and your geographic location.
  • Home inspection – While an appraisal will be performed to establish the market value of the home, it does not address deficiencies with the property unless they are obvious. A home inspection is recommended – but not required – whenever you purchase a home. The cost will generally be between $200 and $400. But it can be money well-spent if it identifies costly problems that you can have repaired by the seller prior to closing.
  • Real estate transfer and mortgage taxes – Many states impose taxes based on the value of the property being transferred or the amount of the mortgage, and sometimes both. It will typically be a small percentage of the property value or the mortgage amount, and will vary by state and county, and sometimes even by municipality.

There are actually two alternatives that can either reduce or completely eliminate closing costs:

  1. Negotiate for the seller to pay your closing costs – This will only be permissible in areas where this is common practice.
  2. Negotiate premium pricing with your lender – This is where you pay a higher interest rate on your mortgage in exchange for the lender paying the closing costs.

Either may be a good option, particularly if you are making a minimum down payment, like 5%, and adding closing costs on top would make your cash outlay significantly higher.

Moving Expenses

It costs money to move homes and your moving expenses won’t show up on a settlement statement. Have a plan and set a budget. Waiting until the last minute adds stress and costs, and is one of our top 16 home-buying mistakes.

If you plan to buy a house out of state that is a long distance away, you may want to consider hiring professional movers. In that case, Tuesdays and Wednesdays are the least busy and offer the best deals. Moving near the beginning of the month is another way to save money.

If you plan to move by yourself, account for the costs of packing boxes, heavy-duty tape, Sharpie markers, and equipment rental.

Acceptable sources of funding for a down payment

Exactly where your down payment funds come from will depend on the type of mortgage you are applying for. In some cases, the down payment must come from your own funds, such as your bank account. But in other cases, it can come from a gift or even be borrowed from approved agencies.

Conventional and jumbo loans tend to have the strictest rules when it comes to the source of your down payment funds. If you are making a down payment of 5% or 3% of the purchase price, the lender will typically want to see that the funds come from your own financial resources. That can include money withdrawn from a bank account, funds withdrawn or borrowed from an employer-sponsored retirement plan, or even the sale of a personal asset.

Typically, once you satisfy the “own funds rule”, the guidelines become more relaxed. For example, if you’re making a 10% down payment, the lender may require 5% coming from your own funds, and 5% from a gift from a relative. But if the gift is equal to at least 20% of the purchase price of the property, the lender won’t require you to show evidence of your own funds at all.

FHA loans have a more relaxed view of down payments entirely. Not only can the down payment come from either your own funds or from a gift, but they also allow loan proceeds from approved down payment assistance programs. It can make it possible to get 100% financing on an FHA loan.

With VA loans, the down payment isn’t typically an issue. VA loans normally provide 100% financing, which makes the down payment a moot point.

Where you can’t get down payment funds from

Two generally prohibited sources are cash and unsecured loans.

By cash, I mean currency you store at home or in a safe. Any money you invest into a home has to pass through a financial institution to be considered a legitimate source of funds. In addition, cash savings in the form of currency can’t be verified as being valid.

Unsecured loans are a no-go. If you have any ideas to provide a down payment from a credit card advance or the proceeds of a personal loan, this will be rejected by the lender. Not only does it indicate an inability to accumulate funds for the down payment, but it also creates an additional debt obligation.

Additional costs to prepare for

We’ve covered costs to open and close your loan, cash for an earnest money deposit, and keeping your bank account healthy enough to show you can make your ongoing monthly mortgage payments.

But there are a few other expenses you should plan for, too:

  • A home inspection — Before finalizing your home purchase, you’ll want an independent home inspection which can reveal major and minor defects before you buy. Expect to find some minor and cosmetic problems; if the inspector finds structural or safety issues, you’ll want to consider buying a different house or negotiating with the seller to resolve the issues before you buy. A home inspection typically costs between $250 and $400 for an average-sized home
  • Moving expenses — If you have friends and family members who happen to have trucks and strong backs, you may not need to worry much about moving expenses. But if you’re moving to a different area or across the country, moving can easily cost $3,000 to $5,000. If you’re moving for work, ask whether your new employer will help cover moving costs
  • An emergency fund — A job loss or an unexpected major repair at your new home could compromise your ability to pay your mortgage. Most financial advisors recommend keeping a few months’ living expenses set aside for emergencies. That way you won’t run up credit card debt just to pay your bills

New homeowners often underestimate the amount of cash they’ll need both upfront and after the home sale closes.

Budgeting for related costs — like moving and new home repairs — will help you put together a more realistic estimate of how much money you really need to buy a house.

The Bottom Line

It’s not impossible to buy a home if you don’t have much cash saved up for a down payment. Shopping around for the right lender and loan type is a critical step. With a lower down payment, expect to pay higher loan fees and interest rates, as well as PMI. Also, don’t forget to tap into down payment assistance programs offered by your state or city. If someone offers a financial gift toward your down payment, make sure they understand it cannot be a loan.

There’s no shortcut to saving for a down payment: It takes time, discipline, and effort. But the result—purchasing a home of your own—can be rewarding, both financially and personally.

Tags

Leave a Comment