Do you need help saving to buy a house? What you think you need and what you actually need may not be the same. Let’s look at what you should know when saving for a home.
In order to purchase a home, you need at least 3.5 percent for a down payment. Another option is Down Payment Assistance (DAP). DAP allows you to pay little to no money down. However, we’re going to talk about wanting to save even more for a larger down payment.
Saving for a down payment is a smart financial move if you can save a substantial portion of your income. For example, if you plan to purchase a home in two years, save 10 percent of your gross monthly income. If you plan to purchase a home in one year, take a more aggressive approach and save 20 percent. Both of these figures give you a realistic depiction of owning a home, instead of dreaming about it.
You do not need a large down payment to purchase a home. The common response “I am waiting to buy a house until I have a big down payment” is driven by the misconception that a larger down payment will make your mortgage payment smaller.
Here’s what’s wrong with that type of logic: it is true that 20 percent down, for example, versus 3.5 percent down is going to dramatically change your payment. There is a big difference between saving up for 20 percent down if you’re in the 3.5 percent down range ‘as is,’ if payment is what is driving the need to save.
Consider housing prices in your area. Let’s say housing prices in your area are $475,000 and you have 3.5 percent down. Let’s also say, for comparison sake, you have the money for closing costs. However, you are deciding to save, because you are looking to get a lower monthly mortgage payment or avoid PMI. If housing prices in your area are rising because of low inventory and large demand, prices could be rising faster than you are able to save. This means you are actually going backwards by saving. Another thought to consider is by getting your foot in the door, you’re getting a couple benefits you do get while renting.
• Forced savings: You’re not getting the benefit of a forced savings account, as part of your payment goes to principal and part of your payment goes to interest.
• Appreciation: You’re not getting any market forces working in your benefit, on the property that’s appreciating the rent you pay for, your landlord is.
• Tax deductible: Property taxes and mortgage interest are 100 percent tax-deductible. This is another benefit you forgo each month you continue to rent.
Saving for a down payment is important, but saving extra money to try and lower your mortgage payment can be a losing proposition. Especially if the market forces are stronger than your savings rate. If you were to purchase a house, could afford the mortgage payment, be backed by market forces, you could leverage the market. Perhaps in two years’ time, even be able to refinance to drop the mortgage insurance. This would subsequently reduce the mortgage payment you had been trying to save a larger down payment for.
The take away here is not to buy a house, just because you have the down payment, but to be strategic about it.
Consider all of your options thoroughly, so you can make the most informed decision about your financial future and what home ownership might mean for you.
Scott Sheldon is a local mortgage lender, with a decade of experience helping consumers purchase and refinance primary homes second homes and investment properties. Learn more at www.sonomacountymortgages.com.