While low mortgage rates have been inviting to potential home buyers in recent years, in many cases raising a down payment is a stiffer hurdle than it was a decade ago. People who are saving up to buy a home often focus exclusively on clearing that hurdle, but those who want to live comfortably in their new homes would be wise not to put every penny of savings into their down payments.
The Down Payment Hurdle
During the housing boom, mortgage lenders were willing to make loans with little or no money down for a simple reason: soaring real estate prices would soon build the home equity that lenders count on as a cushion of security for their loans.
When the real estate boom ended, so did most low-down-payment mortgages. Today, 10 to 20 percent down payment requirements are common. This raises the savings hurdle, and that may not be such a bad thing. A bigger cushion of home equity gives the borrower more flexibility to refinance a mortgage if the opportunity occurs.
To be sure, some FHA home loans backed by the US Department of Housing and Urban Development still offer down payments as low as 3.5 percent. Even so, as long as housing prices can fluctuate by 3.5 percent or more almost in the blink of an eye, borrowers should think about whether they would be more secure starting out the loan with a bigger cushion of home equity. After all, the ultimate focus should not be on simply clearing the down payment hurdle as quickly as possible, but on the best way to secure home ownership for the long term.
5 Reasons not to Clean out Your Savings
Whether your down payment target is 3.5 percent, 20 percent, or somewhere in between, your focus on clearing the down payment hurdle should not be so single-minded that you clean out all your savings to do it. Here are five reasons for keeping some money in reserve:
- Job setbacks. The employment market remains shaky, and the median stint of unemployment these days is 16 weeks, according to the Bureau of Labor Statistics. You need to keep a reserve that will get you through a period of joblessness if need be.
- New budgets take getting used to. At first, a budget is just a theory; you need to find out how making a monthly mortgage payment works out in practice. Having a little money in reserve will give you something to fall back on if the practice turns out to be harder than the theory.
- Home repairs. The first rule of home ownership is that there is always something that needs to be fixed, updated, or replaced. If you do not leave some savings in reserve for this, you will find yourself caught short.
- Filling the extra space. First-time home buyers coming from an apartment or their parents’ home often find themselves well short of the amount of furniture needed to fill a house. You should take your time filling in the empty spaces, but having some cash on hand will help you get started.
- Other unexpected expenses. When people plan for a mortgage payment, they typically build that payment around their expected expenses. So what happens when an unexpected expense crops up? Anything from a car repair to a baby on the way can suddenly re-write your budget, and having a cushion of savings will help you meet the unexpected without jeopardizing your mortgage payments.
Building your home buyer’s war chest
In a sense, would-be home buyers have to balance two conflicting goals. According to mortgage finance company Freddie Mac, current home mortgage rates are still below 4.5 percent, which makes them extremely low on an historical basis. So, one goal might be to secure a loan as quickly as possible to lock in these low mortgage rates. However, to make sure the mortgage is manageable once you are in the home, another goal should be to save a war chest that goes beyond what you will need for the down payment.
The idea then, is to revamp your budget so as to save as much money as possible. This will help you both save more and save faster. That is easier said than done, but in a sense, saving for a down payment should be a dry run for making your monthly mortgage payments. After allowing for whatever rent you are paying, your monthly savings before you buy the home should be at least as much as your planned mortgage payment. Otherwise, how do you expect to make those payments when the time comes?
Potential home buyers often feel a sense of urgency to get into the market. That sense of urgency is a good motivator, but it should be balanced by the knowledge that this is a very long-term decision. Too much haste really can make waste.