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The purchase of a home usually entails saving for
three up-front costs. The down payment is the largest part and
is a percentage of the total purchase price of the house. As
the economy has improved and home prices have stabilized in recent
years, down payment requirements have dropped considerably. Today,
first time home buyers can actually purchase a home with no down
payment. However, putting even a small down payment down of 3%
or more can help you get a much better interest rate.
In addition to a down payment, funds are needed to cover closing
costs. Closing costs include all fees required to execute the
sales transaction, such as attorney fees, title insurance, appraisals,
points and tax escrows. While these charges vary considerably,
most home buyers will need at least a few thousand dollars for
closing costs.
Finally, home buyers need to show that after paying the down
payment and closing costs they will still have some reserve funds
to protect against short-term cash flow problems. Ideally, a
home buyer will have at least three months' worth of housing
payments available after closing. These funds do not need to
be paid out; they simply remain in the home buyer's savings.
Many programs today do not require any reserves at all.
As an example of total cash that used to be required, a home
buyer purchasing a $200,000 home with a $1,750 monthly housing
payment would need to have approximately $20,000 available. This
includes $10,000 for a five percent down payment, approximately
$5,000 for closing costs and about $5,000 in payment reserves.
After closing, the home buyer would have $5,000 left over.
Today, borrowers can purchase a home with no down payment and
in many cases have the seller or lender finance closing costs.
With no down payment or closing costs needed at closing, borrowers
only need to show that they have reserves. Even though a borrower
might not need reserves for a loan program, it is a good idea
to actually have money set aside in case of emergency.
Based on the requirements outlined above, future home buyers
can develop a savings plan that will help them achieve their
goal of home ownership in the near future. Since the down payment
required depends on the purchase price, a home buyer should meet
with a mortgage lending professional to determine how large a
mortgage can be obtained. The maximum loan amount will determine
the approximate price range in which a home buyer should be looking.
For example, a home buyer whose income will support a mortgage
of $190,000 can look for homes with a price of about $200,000
and plan to save a down payment of at least $6,000.
Before starting a savings plan, a future home buyer needs to
determine his or her current financial position. This includes
reviewing all assets and liabilities, developing a budget and
planning how much to save each month. When analyzing total current
assets, a consumer should not overlook any source of funds. In
addition to all checking and savings accounts, many people have
CDs, stocks, mutual funds and savings bonds. Retirement funds
such as a 401k or an IRA can be counted toward the payment reserve
requirement, but only 70% of the value of those accounts. Some
401k plans even allow employees to borrow against the plan. Proceeds
from borrowing against one's own retirement funds can be used
toward a down payment.
By subtracting all current financial assets from the amount of
funds needed to purchase a home, one can determine how much needs
to be saved. A cash flow budget should then be prepared to determine
how much can realistically be saved monthly. Some sacrifices
of non-essential items may need to be delayed temporarily in
order to meet each monthly goal! No matter how a home buyer accumulates
funds to purchase a home, careful planning will always smooth
the road to home ownership.
As savings increase and the opportunity to purchase a home draws
nearer, home buyers need to make sure that all funds saved are
fully verifiable. Mortgage lenders have tightened verification
procedures for down payments to insure that all of the funds
a borrower claims exist and were not borrowed surreptitiously.
The number one source of mortgage fraud in the 1980's was consumer
misstatements about their financial assets.
Many would-be home buyers look into renting a home with an option
to purchase as a method of saving a down payment. In these transactions,
the seller/landlord will credit a portion of the monthly rent
toward the purchase price. Only the portion of a rental payment
that exceeds the fair market rent can be applied to the down
payment. Few homeowners are willing to engage in this type of
transaction. As a result, home buyers may be better off simply
staying where they are, saving on their own, and then purchasing
a home they really want.
Of course, the easiest way to save is to receive a gift from
a relative. More than half of all first time home buyers receive
gift funds from relatives in order to help with their down payments.
No matter how a home buyer accumulates funds to purchase a home,
careful planning will always smooth the road to home ownership.
Michael Licamele is the Editor of MortgageAlmanac.com
and President of Residential Finance Network at rfnc.com.
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