The home buying process can be overwhelming. It is a big financial commitment that requires patience, knowledge, and preparation. When planning for a home purchase, you should consider many factors. Here are several things to keep in mind when buying a home:
Have A Timeline
Identify when you want to purchase your new home. Establishing a realistic timeline allows you to save without stretching your financial capabilities. The more you can save towards your down payment, the less you have to finance, which saves you on interest payments.
Identify How Much You Want To Spend
It is crucial to pinpoint a specific home price that fits your overall budget. It is critical to recognize your needs vs. wants. This allows you to prioritize what matters most while cutting out the unnecessary bells and whistles. Be practical. Understand that the more expensive the home, the more expensive the mortgage payment.
How Much It Will Actually Cost
If you are a few years away from buying, it is imperative to account for housing inflation. Home prices increase over time, so the house you want today will cost more when you are ready to buy (barring a decline in home values, which is rare). As shown above, we increase the value of the home by 5% annually to give a more accurate home price when it comes time to buy. Failing to consider housing inflation might prevent you from reaching the savings goal needed, which could hurt your ability to get the mortgage loan and terms you seek.
Create A Down Payment Goal
Determine how much you want to put toward your down payment as a percentage of the home price. The general rule-of-thumb is a 20% down payment. If you cannot meet the 20% threshold, you will have to pay mortgage insurance. Due to the smaller down payment, mortgage insurance allows you to obtain a loan that you might not otherwise be able to get. The costs of mortgage insurance can vary depending on how much of a “risk” you are to the lender.
Generally speaking, I suggest saving for at least a 5% down payment. That way, you can keep pace with housing inflation. Although lenders will allow you to put down a small percentage, save as much as you can, and shoot for a 20% down payment.
Use Current Savings
The more you currently have saved, the less you additionally need to save toward the down payment. Your down payment goal minus your current savings is the amount you should plan your savings around.
Develop A Savings Plan
Establish a monthly savings plan to reach your goal. To help explain, let’s take a look at the chart above. For scenario #1, the future amount needed for a 10% down payment on a $386,000 home is $39,000. This individual already has $15,000 saved up, which means they need to save $24,000 in the next two years or $1,000 per month. Create a goal, develop a plan, and execute.
Avoid Losing Value
If your home purchase is more than two years away, there are advantages in investing those savings. As demonstrated above, line #7 highlights the monthly amount needed if the funds are invested, which assumes earning 7% annually. This reduces the monthly savings required to meet your down payment goal. As a result of needing to save less, you now have the flexibility to put the $200 (Scenario #1) or $400 (Scenario #2) elsewhere.
Alternatively, if you prefer to stick to the monthly savings required in line #6 AND put that money to work, your savings would surpass your down payment goal. As mentioned, a larger down payment results in a smaller loan, which saves you on interest paid down the road.
As always, if you do invest, consult a qualified professional to help construct a plan that addresses what you need to earn to meet your goals. The above 7% return assumption is not guaranteed and only meant for illustrative purposes here.
I encourage you to use the steps above if you are looking to buy a home. Rather than saving blindly, this step-by-step guide provides a focused approach so you can afford your ideal home when it comes time to buy.
I hope you enjoyed reading!
Joshua J. Baird
Investment Adviser Representative