A good strategy to save the down payment and closing costs to purchase a home requires several steps. While saving money towards the down payment is always good, it’s not necessarily the place to begin. Your first house is probably the biggest investment you’ll ever make. Accomplishing it takes not only perseverance but also good planning.
Do you plan living in your first home for many years (maybe until children have moved out) or will your first place be a short term stepping-stone to a bigger long term home? Obviously, it will take longer to save for a $350,000 home than a $175,000 starter home. Once you decide on that basic strategy, you need to determine how much home your income will actually qualify you for. There are several variables involved but also several resources to help you figure this out. The income calculation includes the mortgage (principle and interest), property taxes, homeowners insurance, and private mortgage insurance if making less than a 20 percent down payment. The resources that help you figure out how much house you can afford include loan officers and online affordability calculators such as zillow mortgage-calculator-house-affordability.
The amount varies but most lenders limit this basic monthly payment to 28 percent of before tax monthly income. Of course, you have other debts like car payments, credit cards, child support, and student loans. Generally, your before taxes total debt to income ratio is limited to 43 percent. For example, if you pay $1,500 a month for your mortgage and another $100 a month for an auto loan and $400 a month for the rest of your debts, your monthly debt payments are $2000. ($1,500 + $100 + $400 = $2,000.) If your gross monthly income is $6,000, then your debt-to-income ratio is 33 percent. ($2000 is 33% of $6000.)
That’s the basic information for determining how large of a mortgage you will qualify for. The total home price can be as high as the mortgage amount plus your down payment. Which means if you qualify for a $160,000 mortgage and make a $15,000 down payment, you can afford a $175,000 home. Your savings will also require another $2,500 to $4,000 for closing costs plus keeping something in reserve for an emergency.
Deciding how dramatic to be about saving for a down payment is a personal decision. Some people prefer to cut back on their lifestyle drastically for 12 to 18 months to get the savings done and over with. Others will cut back on some luxuries and stretch the savings period over 5 years or more. Saving dramatically can mean taking in a roommate to lower rent costs, cutting out cable and smart phones, driving an older car, selling assets, and whatever else you can think of.
Those spreading it out over more time still need a strong savings plan they adhere to rigorously. Some might choose to pay off high interest debt first to increase the remaining discretionary income (to apply towards savings). Once you start saving, pay yourself first. Start an automatic savings payment from your paycheck or write that check to your savings even before paying other bills. If you absolutely have to, you can pull some back for living expenses but you’re more likely to leave more of it in savings than if you make that deposit after all of your other expenses.
Even if you’re stretching it out a few years, you should cut back on vacations and other luxuries as well as consider a side hustle to bring in temporary income. Since you won’t be touching that savings for a few years, think about putting some of it into account paying a higher rate of return. Look into online banks that pay more interest or consider the stock market but limit that to no more than 25 percent of your savings to minimize risk. Also send any pay bonuses or income tax returns directly to your savings.
Something else you may be able to consider is funding part of your down payment from your 401(k) retirement account (maximum of $50,000). But be careful, if you fail to repay the loan in time you’ll have to pay income taxes and penalties on what you withdraw. On the other hand, the interest you pay on the loan is to your own retirement account.
Buying a first home is a tough nut to crack. One that is easiest to accomplish when you create and follow a plan to become a homeowner.
What suggestions do you have for first time buyers? Please leave a comment below.
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