Saving for a house

Saving for a down payment on a house can help you lower your monthly payments and avoid private mortgage insurance.

As a young professional, one your first financial goals may be to become a homeowner. Although new programs are now allowing first-time home buyers to make the purchase without a down payment, having a substantial down payment can end up saving you money in the long run.

Private mortgage insurance
While there is no rule about how much your down payment should be, a good general guideline is 20 percent of the purchase price. Why 20 percent? You can avoid paying private mortgage insurance, or PMI. This insurance protects the lender in case you default on your mortgage payments by ensuring that the outstanding balance will be paid off. The cost of PMI varies but, in general, it’s about one-half of one percent of the mortgage amount per year, or $500 for a $100,000 loan, (which would add just over $40 a month to your mortgage payment). However, you should also consider that the lower your down payment, the higher your interest rate. So in addition to the cost of PMI, your mortgage payment could be higher as well due to the interest rate.

Piggyback loans
If you don’t have 20 percent, you may want to look into other options in which you can avoid paying PMI, like an 80-10-10 program. Also known as piggyback loans, these mortgages let you make a 10 percent down payment, with a primary mortgage covering 80 percent of the purchase price, and a second mortgage for the remaining 10 percent. As with PMI, this is a more expensive option than a 20 percent down payment, because the interest rate on the second mortgage will be higher.

Your down payment amount can also help you figure out what price home you can afford. A guideline that many lenders follow is that no more than thirty-five percent of your total monthly income should be spent on your mortgage payment. So the more you are saving for a house, the lower your monthly mortgage payments will be, which means you may be able to afford a more expensive home.

Before you get ahead of yourself, remember that you must first start by saving. To reach your goal sooner you can cut back on discretionary expenses such as eating out and clothing.