Even though I’m a huge debt-free advocate, I totally understand that purchasing a home in cash can be a steep hill to climb. Don’t get me wrong, it is possible to purchase a home in cash (my friend Kim did) but in some cases it can make sense to take out a mortgage for a home.
It’s no secret that there is a renting crisis happening here in the United States. Many of readers face the struggle of having their rent eat up so much of their income that they are financially strapped. The “rule of thumb” if you will when it comes to how much your housing payment should cost you every month is no more than 30% of your take-home pay. So, if your home is costing you more than 30% of your income, you’ll have to make some hard choices.
If you’re planning to purchase a home within the next few years, here are some of the steps you need to take in order to make sure you have a solid amount set aside to put down on your home (yes, you need to have a down payment).
1. Emergency Fund
Here’s the thing, I’m a firm believer that you should no start saving for a down payment on a home until you have at least a starter Emergency Fund of at least $1,000 set aside for emergencies. By having this fund in place, you’ll be able to avoid many of the hiccups that life throws at us without having to take on debt.
2. Set the goal
How much do you want to put down on a home? $5,000 or maybe $10,000? Or maybe you’ll want to be awesome like my friend Shannon and put down over $20,000 on your dream home! It doesn’t matter the amount, set the goal and start getting aggressive about reaching this goal.
The other big thing you’ll have to consider is your timeframe – how long are you willing to wait before purchasing your home. Also, how much room do you have in your budget to set aside for the down payment?
If your goal is to save $5,000 in a year for a down payment on a home, you’ll need to set aside roughly $96 every week in order to meet your goal. Once you know how much you have to set aside every week (or payday) you can start attacking your plan and making progress.
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3. Know your credit
Yes, I get that it is strange that I’m talking about credit on a blog dedicated to teaching others how to live a life free of using credit, but regardless, if you’re planning to take on a mortgage, you’ll have to know what your credit report says about you and what your score says.
You can pull your report on annualcreditreport.com for free four times a year and I highly suggest you do this so you can identify any mistakes on your credit report now. Make sure you reconcile any delinquent accounts and find out what your FICO score is (i.e. your credit score).
Remember that it takes about 3 months for things to be reported to the credit bureaus, so make sure you do this as soon as possible so you can make sure that your credit report and score are updated correctly before you apply for a mortgage.
4. 15 vs. 30 year mortgage
Okay, so this is a big one and honestly, my viewpoint on this one gets looked down upon by other financial gurus because yes, the math doesn’t make sense. But I don’t know about you, but sometimes math and real life don’t go together – I mean, we’re not robots after all.
So here’s my opinion – unless you truly believe that the mortgage payment you would have with a 15-year mortgage is easily doable, go with a 30-year mortgage with it planned that you’ll pay more to the principle every month.
Please notice how I said “easily” pay the payment of the 15-year mortgage because even if you can pay it now, what happens if you end up getting hit by a major financial blow and you can’t pay? I have friends that purchased an older home with a 15 year mortgage and 20% down (more on this in a minute) and the payment is super easy for them to make every month with just the husband’s income. However, if we had done that, we wouldn’t be able to continue affording that payment if we got hit with a major medical bill.
Also notice that I said to plan to pay more than the 30-year mortgage payment because seriously, who wants to pay on a house for 30 years? And let’s get even more real – do you really think that in 30 years you’re still going to be living in that house?
Okay, so I have to mention this because this is something that we weren’t aware of when we purchased our home. If you put less than 20% down on your home, you will have to pay for PMI (Private Mortgage Insurance). For us, it was an additional $60 every month, which wasn’t necessarily horrible, but here’s the thing – even after we paid our mortgage down by more than that 20% we still had to pay the PMI because they required it for 5 years.
So be prepared that this will get tacked on to your mortgage if you put less than 20% down. Industry standard requires at least 5% down, but I know that our broker talked us into just putting the 5% down (we had 10% saved). If you are planning to move to another area, head here for a cost of living calculator to help you determine about how much you can expect to pay for things in the new area.
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