Saving for a downpayment on a home. That sentence causes a lot of stress for a lot of people and makes many hopeful homeowners believe they won’t ever own a home. Today we want to dispel some of those fears and bring you a little bit of hope, peeling back the complexity of buying a home.
Saving for a home down payment might not be the real issue
Before we jump into the cost, let’s break down some of the biggest obstacles most potential homeowners face:
Credit is often a bigger obstacle than the down payment. Most loan originators and banks consider a sub 640 credit score too great a risk and won’t lend, though to be fair, they aren’t to blame (see the Subprime Mortgage Crisis). The US average credit score usually sits around the 680 mark. To make matters worse, the lower your credit score, the greater the risk to the lender, and the higher your interest rate. It’s best to know what your score is before you begin looking into financing a home. Credit repair (in most cases) will only take six months to a year, so don’t be scared and think home ownership is out of reach.
An acronym you might have heard thrown around is ‘DTI,’ which stands for Debt to Income. This is, as you might have guessed, the amount of debt you have compared to your pre-tax income. While it might sound simple, it’s not. Utilities are often not included in this ratio, and like we just mentioned, it’s based on your pre-tax income.
Income: You make $20 an hour and work 40 hours a week. That means you make $3,464 per month ($20 X 40 hours X 4.33 weeks in a month).
• $400 in student loans
• $80 a month toward credit cards
• $350 a month car payment
• Your total debt is $830 a month and the home you’re considering purchasing will cost you $1,000 a month (property tax and insurance included).
Your DTI would be $1,830/$3,464 = 52.8%.
Most lenders and loan programs would consider this DTI too high and too great a risk (though that’s not always true). 43-45% is usually as high as they’ll go. This is a safe range for you to also consider as the cost of owning a home extends well beyond the monthly mortgage and into lawn maintenance, appliance repair and replacement, utilities, etc.
These aren’t the only factors, but they are the biggest. A few other details that might stand between you and homeownership include:
• Length of time on your job (2+ years is ideal).
• Whether the new mortgage would be a major ‘shock’ to you financially (going from paying $400 to rent to having a $1,500 mortgage payment).
• Some loan programs (VA, State-Funded) calculate the number of residents that will be living in the home and must include their income to make sure you don’t actually make too much money for assistance.
• Collections that might be outstanding on your credit.
Phew, now that the not-so-fun stuff is out of the way, let’s talk about some of the best ways to go about saving for the down payment on a home, and why it might not be as expensive as you think.
The true cost of buying a home
Every loan program is different.
• FHA requires 3.5% of the total cost of the home come from your own money
• A traditional Fannie Mae or Freddie Mac loan, often called a ‘Conventional Loan’ prefers 5% down (with some first-time homebuyer programs only requiring 3%.)
• USDA loans require… brace yourself… $0 down in most cases, but are really tight on their requirements (particularly your DTI) and will only lend in certain areas. One home may fall in their territory, while another just down the street doesn’t.
• VA loans are for those that have served our country and don’t always have a down payment.
• Not to further complicate matters, but there are also state-funded homeownership programs that will actually assist you with a down payment, to be repaid if you sell the home in a certain amount of time.
If possible, it’s always best to put down 20% so you avoid paying Mortgage Insurance - which is additional protection for the lender and can run you $50+ per month depending on the cost of the home and your credit score. We know that that is rarely an option. If it was, you wouldn’t be reading this.
The important thing? You have options. If you were to buy a $150,000 home and put down 5%, you’d be bringing $7,500 to closing, assuming you get seller assistance with closing costs (attorney fees, taxes, etc). Realistically you’re looking at $8,000+. If you found a home you loved in a USDA-approved neighborhood, you could potentially move in and not pay a penny.
Saving 5% of the total home cost is the safest bet, but if your credit score and income are in a solid place, you might already qualify!