Saving for the Home of Your Dreams

Saving for the Home of Your Dreams
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Buying your first home takes planning and budgeting. Depending on the home price and your financial situation, your down payment and closing costs can range from a few thousand dollars to tens of thousands of dollars. First-time homebuyers can spend years saving for the home of their dreams, but there are other ways to get the funds for your purchase that don't take quite as long.

Home Loan Basics: The Down Payment

The down payment is your out-of-pocket contribution to a home purchase. Down payments are expressed as a percentage of a home's price, so you will likely hear lenders or real estate agents describe down payments in terms of "20 percent down," "10 percent down" and such, when discussing your financing options and how you will write up your offer to purchase.

Together with a home loan, or mortgage, your down payment helps to cover the full price of the home. It goes to the seller at the close of escrow, or the finale to the homebuying process, also known as settlement, or "closing." Your down payment reduces the mortgage lender's risk in loaning you a large amount of money for a home. You stand to lose your down payment investment if you fail to repay the loan, and the lender forecloses. This is why most lenders require a minimum down payment from homebuyers.

For example, say you want to purchase a home that costs $200,000 and a lender tells you that you qualify to "put down" as little as 3.5 percent. Your down payment amount would be $7,000.

Typical down payment amounts are 3.5 percent, 5 percent, 10 percent and 20 percent, although your down payment requirement can fall anywhere between and even exceed 20 percent, depending on your financial qualifications. Some loan programs, such as "VA loans" from the Department of Veterans Affairs, require no down payment at all as a benefit to military veterans.

Other government and nongovernment-backed programs provide incentives to first-time homebuyers specifically. Because it can be difficult for first-timers to come up with a hefty amount of cash to get into their first home, these down payment assistance programs can loan or grant you money for the down payment.

Down payment assistance may come in the form of grants that don't need to be repaid, or loans that do need to be repaid, but at a later, more convenient date, such as when you sell or refinance your first home.

Home Loan Basics: The Closing Costs

The other major expense you'll likely need to save for are closing costs. Closing costs are the total fees you pay to the many parties who provide services in the homebuying process, such as a title company, escrow company, attorney, lender and appraiser.

Typical closing costs cover services such as:

  • Credit check
  • Processing, administrative and document preparation 
  • Lender origination fee
  • Courier or messenger
  • Recording
  • Notary

Other common closing costs include prorated, or the advance collection of, these costs:

  • Property taxes
  • Mortgage interest
  • Homeowners association, or "HOA" fees
  • Mortgage insurance, also known as "MI" or "PMI"
  • Hazard insurance premiums
  • Home warranty
  • Escrow impounds 

An escrow impound account may be required when you have less than a 20 percent down payment. Escrow impounds act as a cushion that the lender can use to pay the home's property tax and hazard insurance bills on your behalf when they come due. The lender collects escrow impounds as a precaution so that you don't default on those necessary obligations and jeopardize the home.

You might also need to get PMI when you have less than a 20-percent down payment. This mortgage insurance protects your lender in case you default on your loan.

The total of your closing costs fees can vary widely, depending on your state, home price, service providers and other variables. However, you can estimate the closing costs as a percentage of your target home price, before you find a home and talk to lenders.

In general, you can expect closing costs to range between 2 percent and 7 percent of the home's price. For example, on a $200,000 home with 2 percent closing costs, you would need $4,000, but if your closing costs are 7 percent of the home price, you would pay $14,000 in closing costs.

Why the wide range? State and local jurisdictions impose different fees at closing, such as real estate transfer taxes, and may drive up the cost of title insurance due to their area's legal requirements. Your down payment and loan type can also affect your closing costs. In general, the higher your down payment, the lower your overall closing costs because your loan amount goes down as well as the loan-related fees.

Also, if you have a particularly difficult financial situation, such as bad credit or income complications, your lender may charge you more to finance you. Lenders do this in the form of points. Each point charged equals 1 percent of the loan amount. For example, if you have a home price of $200,000 and you put 20 percent down, or $40,000, your loan amount is $160,000. Say a lender charges 1 point to "originate," or get you a loan, then you pay $1,600 in origination points.

Additionally, Bankrate, a financial resource website, conducts an annual survey of closing costs by state each year. Its estimates are based on a home loan amount of $200,000 with a 20 percent down payment.

Saving for Your Home

There are a few steps you can follow to begin saving for your dream home or to give your current savings a boost:

Build a budget: Budgeting is key to any successful savings plan. Honestly and realistically determine your necessary expenses and stick to spending less than you earn every month.

Cut out excess: Expect to make sacrifices while saving for your home. Skip unnecessary travel and big-ticket purchases until you have your home. In the long run, your house is likely a more important asset than a new car or expensive gadget.

Separate savings: Putting money away for your home can make you feel as if you have a comfortable cushion once you start to see your bank account grow. Open a separate account for your home and make this home-savings money strictly off limits. This will give you a realistic look at how much you have for a house and make you less likely to spend frivolously.

Pay yourself first: If you're on a payroll, have your home savings automatically deducted and placed in your home-savings account each pay period to ensure you're putting money away regularly. You're less likely to miss the money or spend it if you don't receive it directly. If you're self-employed, you can make a similar arrangement by having your earnings sent directly to a specific account reserved for your home purchase.

Stash the extra cash: A work bonus, a tax refund or some other extra cashflow can suddenly give you license to spend. Rather than spending the unexpected funds, put 100 percent of the money away for your home.

Re-route retirement funds: Reduce the money you put into your retirement and put it away for your home. Since owning a home is also a way of securing money for your future, don't feel guilty about moving the funds toward your more immediate goal of homebuying. You should research the terms of your current retirement plan before adjusting any contributions.

Make a move: Moving back in with parents, taking in a roommate or downsizing to get cheaper rent can cut your monthly housing expenses dramatically. Any money you save by making this move can then go directly into your home savings, helping you to meet your homebuying goal sooner.

Shopping for a Loan and Down Payment Assistance

Shop around for a home loan with at least three lenders. Your bank is a good place to start. Get at least one mortgage broker, since brokers have access to multiple banks and different lenders' loan programs. Compare their interest rates as well as the points they charge. A lender may offer a lower interest rate but charge you more in points, or vice versa. They can increase your interest rate in exchange for lower or "no closing-cost" loans. This strategy may work for you if you can't afford closing costs but can afford to make a higher monthly payment on your loan.

Ask if a lender offers down payment assistance programs to help cover your down payment and closing costs, or at least one of these. Your options for down payment assistance vary depending on your qualifications, the lender and your location. Many programs are specifically made for first-time homebuyers, and many states and cities offer homebuyer assistance in the form of grants or loans. A grant does not need to be repaid, and a secondary loan, often called a "silent second," isn't due until a future date, such as the sale or refinance of your home.

If you meet one or more of the following criteria, you might qualify for down payment assistance through a private or government program:

  • First-time homebuyer status
  • Purchasing in a revitilization area
  • Employed in education, emergency response or public safety
  • You qualify as low- or moderate-income while still earning enough to make a mortgage payment