Buying a home comes with huge financial implications, and many of them come into play well before you make an offer and close on your mortgage. You could spend months, years, or even decades saving up the down payment for your home — and that’s especially true if you plan to save 20% or more or if you live in an expensive area.
To make the most of your situation, you’ll need to focus on two main imperatives — figuring out where to save your down payment funds, and deciding on a mortgage that fits in with your budget and your goals.
Many people assume picking a mortgage is a piece of cake, but that couldn’t be further from the truth. While it’s easy to think you’ll just get a 30-year, fixed-rate mortgage because that’s what all your friends and colleagues have done, a home purchase provides the perfect opportunity to think differently about what you really want.
In this podcast, we’ll go over my thoughts on where you should save your down payment if your time horizon to buy is ten years or less. But we’ll also talk about the mortgages available today — and how the obvious mortgage choice isn’t always the best.
Ready to start saving for your dream home? Listen to today’s podcast episode by clicking on the links below:
- Ally Bank Online Savings Account
- CIT Bank Savings Builder Account
- All In One Mortgage Simulator
- Home Loan Gal – Sarah Lindsey
- Should I Invest if I’m Saving for My Next Home Purchase? [Blog]
- Don’t Buy a Home in San Diego — Rent Instead [Blog]
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How to Save for a Home
Buying a home can be expensive regardless, but the price tag can hit the roof if you live in an expensive area like San Diego. And you have to remember, it’s not just the cost of the house itself that can drain your finances. The ongoing costs of mortgage interest, property taxes, upkeep, maintenance, and repairs make owning a home an expensive endeavor.
Still, the main factor that impacts your monthly housing costs is probably the home loan you end up with. Will you get a 30-year home loan? A 15-year loan? A mortgage with an adjustable rate that changes after five or seven years? The decisions you make now can impact not only your monthly payment but also how much interest you pay over the life of your loan.
Beyond just the way you choose a home loan, another factor to consider is where to keep your down payment as it grows. If you are buying in a pricey area and plan to save 20% to avoid private mortgage insurance, or PMI, your down payment could easily reach six figures or more. How and where you invest that money can hurt or help you as you save, but there’s a lot of conflicting advice on the best way to get the job done.
Where Should You Keep Your Down Payment Money?
Well, here’s what I think: If you believe you’ll be using your cash reserves to buy a home within the next ten years, you shouldn’t be investing your down payment money in stocks and bonds.
There, I said it!
That advice may go against the grain depending on who you ask, but I still give it to anyone who will listen.
The thing is, you don’t want to keep your down payment money in a regular savings account earning .01%. My advice is saving your down payment funds in a high-yield savings account from an online bank. Many banks are offering up to 2.5% APY online without any banking fees, so you don’t want your money lingering with a brick and mortar bank that hardly pays anything. Earning 2% or 3% on your money isn’t anything to write home about, but it’s way better than nothing.
You may think ten years is a lot of time, and it is! The thing is, the stock market is entirely too volatile to invest your down payment funds over such a short timeline. You may not get rich with a high-yield savings account, but at least you won’t lose the down payment money you worked so hard to earn.
Think Long and Hard About Your New Mortgage
Next up, let’s talk about the type of mortgage you should plan for. While 30-year, fixed-rate home loans have long been the norm, few people ever think about how much these mortgages cost. But if you dive deep on the details, you may be shocked at how much interest you can pay over three decades of mortgage payments.
Mortgage expert Sarah Lindsey, who is known as the “Home Loan Gal,” offers this statistic to put things into perspective:
If you borrow $300,000 with a 30-year, fixed-rate mortgage at 4%, you’ll pay $215,000 in interest over the life of the loan. That’s $7 for every $10 of your mortgage amount, which is insane. With a traditional mortgage, the bank also sets up your loan so you pay the bulk of your interest toward the beginning.
This is a huge problem. Lindsey says that, on a traditional 30-year loan, you won’t see the amount of interest equal the principal you’re paying in until year 12 or 13. After that, it’s not until years 22 and 23 where you finally reach a point where you’ve paid as much of your principal down as you’ve paid in interest!
Of course, you don’t have to get a 30-year home loan. Lindsey smartly points out that there are shorter term mortgages available, including the popular 15-year, fixed-rate mortgage. Of course, you can also just make extra payments on your longer-term loan, which is a popular strategy for people who want to pay extra when they can.
Making extra payments can absolutely reduce the principal balance you owe, but you also need to remember that any money you pay toward your principal is now locked up in your home’s equity. If you need to access that cash down the line, you would have to refinance your home loan or consider a home equity product like a home equity loan or HELOC.
Consider an “All In One” Home Loan
For that reason, Lindsey suggests taking a closer look at what is called an “all in one” home loan. With an all in one loan, the borrower can combine their mortgage loan and their banking services in a single account.
This strategy allows them to leverage their regular deposits in conjunction with their home mortgage, ultimately saving money on monthly mortgage interest. At the same time, this loan allows borrowers to have easy access to their money if they need it.
But, how does an all in one mortgage work?
“By lowering your balance on your loan, you are accruing less interest as you have that lower balance,” said Lindsey. The easiest way to do this involves combining your loan with a checking account so that money deposited into your account is applied directly toward the principal balance of your loan.
Remember that people don’t pay their bills all in a day. While excess funds are in their bank account and not being utilized, putting that money to work can help them save money on interest.
Another benefit to consider is the fact that, because there’s a lower loan balance while you have excess money in your account, the monthly payment on your mortgage drops. This means that excess funds can do double duty by paying even more money toward keeping the principal of your loan balance low.
Finally, the lower balance on your loan can get pushed into the next month when you have excess funds in your account, meaning the interest savings can roll over and save you even more.
In the end, this lets you save money on interest and access your cash when you need it. On the flip side, the fact that this loan comes with an adjustable rate means you could wind up with a higher rate than you initially signed up for over time.
This may not be the right loan for every buyer, but there are real benefits to consider if you want to save on interest and need some flexibility. At the end of the day, you should consider multiple home loans and spend some time figuring out how each of them might work in your favor.
Saving up for a home is no joke, but there are plenty of ways you can set yourself up for success. Make sure you’re earning plenty of interest on your down payment so it will grow faster, but also remember to keep your mind open when it comes time to choose a mortgage. A 30-year-, fixed-rate mortgage may be exactly what you need and want, but a short-term loan or a new mortgage product may fit better with your lifestyle and goals.
The bottom line: Don’t fall into the trap of doing what other people are doing without thinking it through. Think for yourself and think of what you want, and you’ll always be better off in the end.
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