November 6, 2019 / Scott Blanton / The Homefront
Let’s face it, saving for a down payment can be rough. You have bills, debt, and other obligations to think about. Not to mention the vacation you’ve been planning for months. With those expenses, your dream home can seem like, well, a dream. But, you have options and choices that make saving for a down payment way easier than it used to be.
You don’t need 20% for a down payment. That’s a mortgage myth.
First off, you don’t need 20% for a down payment. That’s a mortgage myth that needs kicking to the curb. Secondly, there are home loans like the USDA loan program that allow qualified borrowers to finance 100% of their purchase. The catch: not everyone qualifies, so you’ll probably still need some sort of down payment.
Here’s the good news, though: there are loan programs that only require 3.5% for a down payment. That’s less than a quarter of the 20% you thought you needed 60 seconds ago. And, it means you don’t have to save for half your life just to purchase a home.
Okay, so say you don’t qualify for that 100% financing, how do you save up for the 3.5% down payment or even 10%?
To start, let’s figure out the benefit of a higher down payment.
The down payment on your dream home serves two functions: 1) secures your loan and 2) helps lower your purchase balance. Let’s dig into those things:
1. Secures your loan
During the entire home loan process, a lender combs through your financial history to make sure you aren’t a risk. Risky borrowers have lower credit scores, high debt-to-income ratios, and a bad bank account history. Your down payment tells the lender that you aren’t a risky borrower. Basically, with a down payment, you’re saying, “Hey, this is my dream home. I’m committed to paying for it and to prove that I’m going to pay this much upfront.”
2. Lowers your purchase balance
After you close on your loan and move into your dream home, you’ll have to start making monthly payments. The down payment goes directly to the purchase price, which means it lowers the overall balance of the loan. The higher your down payment the lower your balance will be. As a result, borrowers who pay a higher down payment pay less over time.
If you can qualify for 3.5% down payment, then why pay more? Because you’ll save money. In some cases, a 20% down payment may not be required, but if you do put 20% down you can eliminate Private Mortgage Insurance (PMI), which is a type of insurance lenders require borrowers to pay to help secure the loan. If you must pay PMI, your monthly payment will be higher. So, a higher down payment may result in less money owed over time and potential of PMI elimination.
Now that you know why you need a down payment, it’s time to figure out how to save for it.
You might be wondering, “how am I supposed to do that?!”. Several of your monthly expenses can probably be trimmed down, which means you can stash away extra money. If you’re paying a cell phone bill, cable bill, or even utilities bills, there might be ways to cut down the costs. Call your providers and ask for options that could save you money. Don’t hesitate to call competitors to get quotes. Often, your current provider will offer a different rate if you tell them you’re switching providers.
When it comes to your utility bills, you can always be more conservative about the amount of water, natural gas, and electricity you’re using. Make sure you turn the lights off when you aren’t in a room, lower your furnace down a degree or two, and take shorter showers. Even if you only save 5 or 10 dollars a month, you could save between 60 and 120 dollars a year.
These cost saving ideas certainly won’t be your only step in saving for your down payment, but they will help you get started.
One of the biggest challenges first-time homebuyers face with saving for a down payment is the will to save the money. No matter how much budgeting you do and no matter how many times you tell yourself that you’ll set the money aside, something comes up. It’s easy to put it off, to say, “I’ll save extra next month.” But, often, next month turns into the month after and so on.
Instead set up an auto withdrawal from your checking account into a savings account specifically for the purpose of saving for your down payment.
The two critical components of this are 1) actually setting up the withdrawal (but, once you do, you don’t have to think about it again) and 2) opening a separate savings account. Don’t muddle your regular savings account with the account you set up for your down payment.
When we say “savings goals” we mean more than however much your trying to save for your down payment. Savings goals are smaller goals that you set for yourself.
For example, if your end goal is $10,000, you might set smaller goals for every $2,500 that you save.
But, setting goals with no reward isn’t much fun. So instead of just setting the goal, celebrate the goal. Saved $2,500? Go to a nice dinner. Saved $5,000 (50% of your long-term goal!)? Head out of town for a small weekend getaway.
The point is to reward yourself for hitting those goals and then remind yourself why you’re saving in the first place.
When you apply for your mortgage, a lender won’t only look at your credit score to determine if you’ll be a good borrower or not. In fact, they look at a whole bunch of stuff. One of the more crucial aspects is your debt-to-income ratio.
This is the amount of money you already owe on existing lines of credit (I.e. credit cards) versus the amount of money you make every month.
A lender wants your debt-to-income ratio to be low, meaning you don’t have a whole lot of debt. While you may not be able to do anything about your debt immediately, you need to be aware of it. The lower your debt, the more you can save for that down payment.
This one may seem obvious given everything we’ve covered, but it’s easy to slip up. Reward yourself and then get back on track. In fact, just get on track. Starting isn’t the hardest part of it. Maintaining is. If you’re motivated to save for your down payment, you’ll be able to stick to your budget. Remember to set goals, trim expenses, and pay down your debts. Doing these things will help you find extra money to stash away and they’ll keep you on the path to homeownership.
Now that you have a better understanding of what a down payment is used for and know that you don’t have to have 20%, what are you waiting for?
The earlier you start saving for your down payment, the better off you’re going to be when it comes time to purchase your home. Even if you think you’re still months or even years away from purchasing your home, our Mortgage Consultants would love the opportunity to speak with you. Talking about your goals, financial situation, and options with a Mortgage Consultant can result in a road map to closing table.
Ready to get started? Check out our easy-to-use online mortgage application! It’s completely free and only takes a few minutes. Plus, you can take your application with you by downloading Mortgage Express, our free mobile app!