How Much Money Do You Need to Buy a House?
The first step and most critical in the house buying process
is getting pre-approved.
Buying a house is still considered to be a lifetime accomplishment. How much cash you’re going to need upfront to do so is another story entirely. The funds needed to close the sale play an enormous role in your ability to get a house loan. If you’re serious about buying a house or will be in the future, you will need to know how much of your income you should be saving to realistically seal the deal?
Short-Term Plan: Lenders look at your pretax income when determining how to qualify you for a mortgage loan. As a would-be house buyer, you should plan on doing the same, using a percentage of your gross income for determining how much to save. Saving 20% of your income could catapult you into possibly purchasing a house in the next 12 to 16 months, depending on your market. For example, if you’re earning $96,000 per year, that’s $19,200 saved after one year. $28,800 saved after a year and six months, which can be plenty of funds to make house-ownership a reality.
Longer Term Plan: At least 10% percent of your pretax income is a great place to start planning for future house-ownership. Using the same example of $96,000 of income, that’s $9,600 per year allocated for house savings. It would only take an extra year to come up with the same type of cash in the short-term plan’s one-year goal.
Taking a percentage of your income is certainly no easy task. It requires diligence, attention to detail and financial discipline to consistently put that money in the bank despite other debts and household expenses.
Income Sources to Supplement Your House Buying Plan
While the following are potential sources for a down payment, make sure you consult with a financial adviser before you tap into your nest egg to make sure it’s the best move for your needs. With that said, here are the options:
• 401(k)s — If you have an employer match a percentage of your monthly contribution, this can aid you in purchasing a house faster, as the majority of 401(k) accounts have the ability to borrow for buying a house as a first-time buyer. For example, if you are receiving a 50% match of your monthly contributions your 401(k), you can kick-start the time it takes you to save the cash.
• IRA — These accounts grow with the market and have the same concept as the 401(k), although without the matching. Such an account is a great place to accumulate money in an interest-bearing account that has provisions to purchase a first house.
• CDs and money market accounts — These accounts also are a source to help you generate additional funds to save in addition to your monthly savings contribution.
You can even set up electronic funds transfers from your paycheck to funnel into these other banking sources in the event saving that money on your own becomes too difficult.
It All Comes Down to Your House Price
When you buy a house, there’s the down payment, which is the difference between the purchase price and the loan amount. And then there are closing costs. Those two costs will equal the total cash needed to close. Closing costs are roughly 2-2.25% of the purchase price. So if you’re looking at a house for $500,000, plan on closing costs to be around $10,000. How much down payment is needed will vary, depending on the loan program.
Down Payment Requirements for Loans
How much cash you will need to purchase a house is dependent on the loan program, purchase price range and your market area.
• Conventional financing – Can be obtained with as little as 5 percent down payment. If the down payment is less than 20 percent, it may be necessary for the loan to have Private Mortgage Insurance (PMI) to protect the lender.
Term: Paid off in equal monthly payments over 15, 25 or 30 years.
Interest Rate: Stays the same for the life of the loan.
• FHA financing – Insures loans, making lenders willing to finance house purchases on favorable terms. Down payments as low as 3 percent. Discount points may be paid by either seller or buyer.
Term: Varies by lender; however, the FHA charges an up-front Mortgage Insurance Premium, similar to Private Mortgage Insurance, that can be financed in the mortgage amount or paid in cash at settlement. The borrower must also pay an annual Mortgage Insurance Premium of 0.50 percent, which is collected monthly.
• USDA financing – The maximum loan amount an applicant may qualify for will depend on the applicant’s repayment ability. The applicant’s ability to repay a loan considers various factors such as income, debts, assets and the amount of payment assistance applicants may be eligible to receive. Regardless of repayment ability, applicants may never borrow more than the area’s loan limit (plus certain costs allowed to be financed) for the county in which the property is located.
What is the interest rate and payback period?
• Fixed interest rate based on current market rates at loan approval or loan closing, whichever is lower
• Interest rate when modified by payment assistance, can be as low as 1%
• Up to 33 year payback period – 38 year payback period for very low income applicants who can’t afford the 33 year loan term
How much down payment is required?
No down payment is typically required. Applicants with assets higher than the asset limits may be required to use a portion of those assets.
• VA financing – Available to qualified veterans of the Armed Services, Reserves and National Guard. Loans can exceed $200,000 with no down payment. Flexible underwriting guidelines. Closing costs may be a gift. Can be combined with second mortgages and are assumable (upon qualifying) by future buyer.
Term: Payment fixed for the full term.
Interest Rate: Varies by lender.
• Navy Federal Credit Union – Needs no down payment – restrictions as to who can apply, members of the military, some civilian employees of the military and U.S. Department of Defense, and family members
• Adjustable Rate Mortgage (ARM) – Characteristics: Low initial interest rate with payments that typically increase over time. Popular with first-time buyers and buyers who plan to move or refinance in three to five years.
Term: Varies by lender. Interest Rate: Subject to change on a periodic basis.
• Balloon – Lower interest rates and monthly payments than fixed-rate loans. Best for borrowers who plan to move or refinance within the loan term. May allow conversion to a fixed-rate loan at term’s end.
Term: 5-7 year loans, amortized over 30 years. Repaid in equal monthly payments plus a “balloon” payment for the remaining balance.
Interest Rate: Varies by lender.
• Buy-down – House owner, builder or third-party puts additional cash up-front in exchange for a lower interest rate.
Interest Rate: Varies.
• Non-Conforming – Provides house buyers with products that do not conform to normal FHA/VA and conventional lending guidelines. These unique loan products are tailored to fit specific financial situations including:
• Bankruptcies less than 2 years from discharge;
• No income/no asset verification loans;
• Late payments on previous or current mortgage;
• Bank statement programs for the self-employed; or
• Excessive credit problems, but sufficient liquid assets to work with.
Interest Rate: Varies.
• Owner Assisted – Owners may finance first, second, third or fourth loans. They may loan their equity back as a first mortgage (often called a “take back”).
Term: As determined by the owner.
Interest Rate: As determined by the owner. Very Seldom Seen
How to Determine Your Costs
Let’s look at a house priced at $500,000. Given certain criteria, $27,500 is what it would take to close the deal. Here’s the math:
• $500,000 purchase price
• $10,000 closing costs (at 2-2.25% of the purchase price)
• $17,500 (a 3.5% FHA down payment)
Giving you a total cash payment of $27,500 needed.
Remember as you are diligently saving a portion of your income to make that house purchase happen: A lower down payment and lower total cash to close means a higher monthly mortgage payment. Conversely, a larger down payment gives you a lower mortgage payment. Also, the percentage of mortgage insurance lowers if a buyer uses more equity.
If you have been diligently saving for a house, and still have not been able to purchase a property and are diligently saving your money, talk to a lender about getting pre-approved. Perhaps it’s time to reevaluate how much percentage of your income is going to saving versus what houses are like in your area.