Like many other homeowners, I researched the heck out of buying my first home: what to look for in a house and location, what kind of mortgage to…Read…
Buying a home is an exciting life milestone, but it can also be intimidating. Your home will probably be the most expensive purchase you'll ever make, so you want to establish a responsible plan for ownership. If you're a little daunted about saving up for a down payment, here's how to get started.
Thanks to the housing crisis, we know the downfall of overspending on a home. When deciding on a price range, find a realistic amount for your financial situation. You may be approved for a full-price loan, but that doesn't mean you should take it. According to finance site Money Crashers, two of the most common mistakes first-time buyers make are overspending and not shopping around for a lender:
"Rather than being excited and accepting the higher mortgage loan, be smart and stick to your original price range. Splurging on a house provides immediate excitement and gratification – but your mood can quickly turn sour once the bills start rolling in...."
"Save money on your first home purchase by simply talking with different lenders...Factors to consider include the mortgage rate, closing costs, down payment, private mortgage insurance, and a potential prepayment penalty."
Set a down payment goal
If you've ever purchased a home, you know how important it is to save a sizable down payment to get the best possible mortgage loan from your… Read…
Once you've found a realistic price range, make a down payment goal. As we've said before, follow the 20% rule. Twenty percent has long been the norm for a home down payment. Before the housing market downturn, people went for 10% because they were being approved for full-price loans. We all know how that turned out.
But there are other reasons to follow to 20% rule. Interest rates are often lower with a higher down payment, according to Trulia. You can also avoid paying private mortgage insurance.
Be financially prepared
Your finances should be in order before you prepare to buy a home. Make sure of the following before homeownership, suggests Kiplinger:
- You know how to budget
- Your income source is reliable
- You have an emergency fund
- Your debts are under control (Ideally, you should be debt-free.)
- Your credit report looks good
Boost your savings
Money blogger Krystal Yee saved for a home down payment in Vancouver, where home prices are high. She boosted her savings with multiple streams of income:
"I went about creating multiple streams of income, and did everything I could to make extra money. I've had two full-time jobs at the same time (a 3-month time frame). Took on graphic design contracts. Started freelance writing. Sold stuff on eBay. Worked for $8-10/hour at a part-time job for years. YEARS. The list goes on. Sometimes you have to do un-glamorous work in the short-term in order to achieve a big goal."
Also, consider areas of your budget that can be reduced. Rent is a big one. Consider a cheaper apartment. Maybe find a roommate.
Pick an ideal savings vehicle
If you plan to buy within the next year or two, most experts recommend you play it safe with your savings. According to Daily Finance:
"When you're saving for a short-term goal, financial experts recommend you stick with a low-risk investment such as a high-yield savings account or a CD...the rate of return on your down payment savings is less important than making sure the money is available when you need it."
If you don't plan to buy for another three to five years, consider a bond fund. The New York Times Bucks blog recommends:
"For people who are still saving and have longer time frames — say three to five years — some advisers recommend considering short-term, high-quality, no-load bond funds. 'Many are paying a dividend of 2 to 4 percent, net of expenses,' said Joshua B. Gottfried, a certified financial planner in Glastonbury, Conn. He pointed to DWS Short Duration Plus (DBPIX), which yields about 3.25 percent annually, minus the expense ratio of 0.65 percent of assets each year. The fund has an average duration of 1.6 years."
Consider tapping into your IRA
If the IRS deems you a "first-time homebuyer," you can use up to $10,000 of your individual retirement account (IRA) funds to pay for a home. And if you're married and your spouse is also a first-time buyer, you can both withdraw from your IRAs, for a total of $20,000.
According to finance site Bankrate, the exemption gets even better:
"Even better is the IRS definition of 'first-time homebuyer.' Technically, you don't have to be purchasing your very first abode. You qualify under the tax rules as long as you (or your spouse) didn't own a principal residence at any time during the previous two years. In fact, you can even share your IRA wealth. The IRS says the first-time homebuyer using your IRA funds for a down payment can be you, your spouse, one of your children, a grandchild or a parent."
You won't incur an early withdrawal penalty, but you will pay applicable income taxes on the withdrawal amount, depending on your account. Don't make this decision lightly. Research siteZacks explains:
"Any time you take money out of your retirement plans, including a Roth IRA, for something other than retirement expenses, use caution. Once you take the money out, you're giving up the tax-free growth indefinitely. You can't 'make up' the difference by putting those contributions back in, should you have a windfall, and so there's no way to make up for lost time to rebuild your nest egg."
Decide whether or not the exemption is a good idea for you. Weigh the cost and benefit, depending on your situation. Zacks explains, " if buying the home using funds from your Roth means you have to pay less for housing in retirement, it might be the right move for you."
Buying a home should be a well-planned process. Develop an effective down payment plan by considering the precautions and weighing your options.