Except for Veterans Administration loans, it still generally takes some cash up front to get into a home. How much cash you’ll be required to have up front depends on the type of mortgage (whether FHA or conventional) and your personal financial situation. The better your credit, though, the lower the down payment the lender will typically expect.
How much will you need to save? If you are applying for an FHA loan and your FICO score is between 500 and 579, plan on a 10 percent down payment or more. If your score is 580 or better, you may be able to qualify for a 3.5 percent down mortgage.
Conventional mortgages tend to have somewhat higher down-payment requirements. You begin to become competitive for a 5 percent down mortgage when you have a FICO score of around 660, though lenders vary widely in practice. However, to save on private mortgage insurance costs (PMI), you may want to go with a VA loan, if you qualify, or save up 20 percent.
So what’s the best way to go about saving that money? Here are the factors to keep in mind:
Safety. Unless you are planning to wait years to buy your home, you don’t want to take a lot of risk with this money. Hopefully, you will have your down payment saved up within a year or two. It doesn’t make sense to risk a large market loss and throw your dream of home ownership off schedule.
Liquidity. You don’t want to lock this money up for years. You want to be able to access your money quickly and cheaply.
Returns. You want to get a reasonable return, or yield, on your money. But don’t sacrifice safety for yield if it means risking your goal of home ownership.
A guarantee. Investments carry risk. But some financial vehicles come with an in-writing guarantee. Examples include balances in checking and savings accounts and share savings certificates at credit unions, which come with a guarantee of up to $250,000 in the event the credit union becomes insolvent. Banks have a typical arrangement via the Federal Deposit Insurance Corporation.
So where should you put your money? Here are some common options that have stood the test of time – along with the advantages and disadvantages of each.
Cash. You can stuff cash in a mattress or coffee can. This is convenient, but not very secure. Your money is subject to the hazards of theft, flood, fire or loss. It also generates no return whatsoever.
Checking or savings accounts. These generally produce a small return, but at least it’s something. They are, however, very convenient, if you are disciplined about not spending the money that’s earmarked for your down payment. If your savings is very small, it may make sense to keep it here instead of paying fees to maintain a low balance account. These are guaranteed against bank failures up to $250,000 per account holder, either from FDIC (for banks) or the National Credit Union Share Insurance Fund, or NCUSIF. Because credit unions are mutually-owned by depositors just like you, you can frequently get a better deal in the long run by using a credit union.
Certificates of deposit (AKA “share savings certificates” at credit unions). These typically pay a higher yield than checking or savings accounts, and also qualify for federal insurance coverage. However, they do require you to commit your money for a specific period of time. The penalty for early withdrawals is usually the equivalent of six months of interest.
Money markets. This is a type of mutual fund that’s made up of low-risk, short-term bonds and commercial paper designed to maintain a stable per-share price of $1 per day. By and large, they have been able to do so, historically, though there are no guarantees. They may offer higher yields than guaranteed accounts, and do not require a time commitment. However, there is a possibility that your money market will lose money. Some financial institutions do offer insured money markets.
Permanent life insurance. If you own a permanent life insurance policy, such as a whole life policy, it accumulates cash value over time. Whole life and well-funded universal-life insurance policies can be effective tools for savers – especially since whole life insurance cash value receives a guaranteed crediting rating and is guaranteed never to decline in value as long as you pay premiums as scheduled.
Individual Retirement Arrangements. You can withdraw up to $10,000 from your IRA to put a down payment on a home with no penalty. For traditional IRAs, you will need to payincome taxes on any such withdrawals.
Thrift Savings Program. If you are a federal employee or member of the United States military, the Thrift Savings Program, or TSP, allows you to borrow money to make your down payment on a home on advantageous terms. For more information, visit www.tsp.gov.
401(k) Loans. Some employers allow you to borrow from your 401(k). Typically, you will need to repay the loan within five years or face taxes and penalties on any remaining balance. However, if you leave your employer, you will have to repay the loan immediately or face taxes and penalties on what you’ve withdrawn. This makes using 401(k) loans tricky for longer terms – especially where employment prospects are not certain.
Whatever vehicles you choose to utilize in accumulating your savings, your credit union is ready to assist. Come in and speak with one of our lending or financial services professionals for a no-obligation consultation, or simply some advice on how to get started. We want to be part of your home-ownership dream.