Saving to buy a home
Before you start shopping for your new place, there are a few things you need to consider first. The most important consideration is the amount of money you will need to buy that dream home.
Home Ownership Pros and Cons
Owning a house is definitely an investment. However, it usually isn't a good short term investment. Consider buying a home only if you plan on staying in one place for at least a few years. Such large purchase will affect your lifestyle in many ways.
Let's consider the benefits first:
- You will be able to deduct your mortgage interest and property taxes from your income, thus saving you money on income tax.
- Making mortgage payment you will build equity and wealth over time.
- Once you accumulate enough equity in your home, you'll be able to borrow money for home improvements or loan consolidation at low interest rates.
- If you live in an area where the real estate market is booming, your house value will appreciate and you are likely to profit from the sale of your house.
- Best of all, you may not need to pay income tax on that gain!
There will be drawbacks, too:
- If you sell your house too soon, you may lose money (unless appreciation outpaces your home payments).
- Your property taxes will always reflect your home value. If it rises, so will the tax.
- If you buy a home in an area, where houses dot not appreciate in value, you may lose money when selling it. That's why it's so important to work with an agent, who can help you evaluate the neighborhood, schools, comparable houses and forecast future appreciation.
- After you close, your costs of home ownership kick in. Make sure you have enough money and enough income to cover your monthly mortgage and escrow (for property taxes and home insurance) payments.
- Home ownership comes with responsibilities. While home insurance will cover the cost of incident, regular maintenance will be your responsibility.
In your particular situation there may be other benefits or drawback that you will need to consider. However, if you're set on owning a home, let's consider how much money you'll need.
Money Needed to Buy a Home
Most people know that buying a home will require saving for a down payment and making monthly payments thereafter. It's true, but there are a few other things to consider.
Before you buy your home, you will need to have money for a down payment, earnest money deposit, closing costs and some cash reserves. After closing, you will need to have income to cover the ongoing costs of ownership: mortgage, escrow (property taxes and home insurance) and in some cases PMI (Private Mortgage Insurance) payments, repairs, maintenance and in some cases HOA (Home Owners Association) fees.
Money Needed Upfront
Let's discuss the upfront expenses first:
- Earnest Money (EM) is a term used to describe the amount of money you're willing to deposit when making an offer on a property. It demonstrates how serious you are about the purchase and can range from a few hundreds to few thousands dollars. That money will be held in escrow until closing and applied to your down payment. If your offer isn't accepted by the Sellers, you'll get the check back. If your offer is accepted and you decide to pull out from the contract for reasons specified in contingencies (e.g. unrepairable flaws discovered during home inspection), you'll get your check back. However, if you decide to pull out for reasons not specified in the contract, your earnest money check will be gone.
- Down Payment is the portion of the purchase price you are willing and able to pay upfront. The difference between the purchase price and your down payment will be covered by a mortgage paid off with tax deductible interest over time. Anything above 20% is considered a large down payment and won't require a Private Mortgage Insurance (PMI). There are a lot of Lenders who offer loans requiring less than 20% down, some as low as 3% (e.g. VA) or even nothing down (e.g. USDA). Your Realtor® will work wit you to find the best Lenders and programs fitting your particular situation.
- Closing costs is a term used to describe all the expenses related to a transfer of property in a real estate transaction. Some costs are covered by the Sellers, some by Lenders, and some by the Buyers. In upstate New York, the expenses covered by Buyers are usually limited to various fees (legal, appraisal, survey, origination, underwriting, etc), as well as title insurance, discount points, etc. While every situation will be different, those costs can add up to a few thousands dollars. Some Lenders will allow to include them in the mortgage loan.
- Cash reserves are savings or investments you'll be able to access in the first few months after closing to cover your ongoing payments. The exact amount will depend upon your debt to income ratio, amount of mortgage, taxes, etc. Your Realtor® will work with your Lender to help you figure the exact amount.
- Consider also moving costs, furniture and appliances you'll have to buy, etc.
After you buy a house, you'll have to consider the following ongoing expenses:
- Mortgage payments will usually be the highest of your ongoing expenses. The exact amount will depend upon many factors like purchase price, amount of down payment, interest rate, repayment schedule, etc. In working with your Realtor® and your Lender, you will know the exact amount before closing.
- Escrow payments are the amounts you or your Lender will put aside to pay for real estate property taxes and home insurance. Since those costs are usually paid annually, most Lenders will create an escrow account to which you will contribute smaller amounts of money during the year, and they will use that money to pay the taxes and insurance premiums.
- PMI is an abbreviation for Private Mortgage Insurance. If the amount of equity (i.e. down payment) in the house is below 20%, the Lender may force you to secure PMI prior to signing off on the loan, if you're taking out a conventional mortgage. The purpose of the insurance is to protect the mortgage company if you default on the note. PMI typically costs between 0.5% to 1% of the entire loan amount on an annual basis. Once the amount of equity in your house reaches 20%, you'll no longer required to pay PMI. Non-conventional loan programs have different PMI requirements, and your Realtor® working with your Lender will be able to find the best option for your particular situation.
- In some situations you may need to consider Home Owners Association (HOA) fees. They're usually assessed on specific types of properties (usually condominiums, or gated communities), and meant to cover costs related to maintenance of properties and common areas, as well as certain kinds of repairs, etc. Consult your Realtor® to figure out the exact amounts needed.
- You'll have to factor in repairs and ongoing maintenance to your new home. Even if the the house is in tip top shape, it's always a good idea to start building up reserves for the rainy days.