During the housing boom, mortgage lenders eased down payment requirements to get more people into homes. The down payment was literally nothing in some cases. In fact, the availability of 110% mortgages — loans for 10% more than the value of a home — amounted to a negative down payment. As any prospective home buyer knows, that kind of deal is history.
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Today’s mortgage borrower is facing quite a different situation. In the wake of the housing bust, lending guidelines tightened, and down payment requirements returned. Then the federal government stepped in with the home buyer’s tax credit, which helped make up the difference for many.
But the tax credit’s gone now too. What’s a home buyer without a down payment to do?
Like it or not, most people looking to buy a home now will have to raise a down payment the old-fashioned way: by saving up for it. And that may not be altogether a bad thing.
Why Saving for a Down Payment Is a Good Thing
Saving up for a down payment does two things in one.
First, having 20 percent or even 10 percent of the sales price to put down fulfills critical qualification requirements that may mean the difference between getting a mortgage and not getting one.
Second, saving your down payment encourages your long-term financial success. With a smaller mortgage balance, you lower your monthly payments for the term of the loan. Less obviously, saving for this lump sum can help you build good financial habits — meaning a smaller chance you’ll find yourself in over your head and facing default once you do purchase a home.
Money Market Accounts: Made for Your Down Payment
A home down payment is a daunting sum, but it can be achieved. If you’re planning on buying a home, one of the first steps to take — before you start looking at real estate listings or researching mortgage rates — is to open a money market account for your down payment savings.
Why a money market account? A money market account is like a traditional savings account, but money market rates are on average higher than savings account rates, and the best money market rates out there aren’t too shabby. These rates may still go up, and you should learn more about the top factors that will affect money market rates in 2010.
You might be able to get better interest rates on CDs, but money market accounts give you more flexibility than CDs for making regular deposits. And when it comes time to pull the trigger on a home purchase, the last thing you want is your money locked up in a long-term CD.
If your time horizon for buying a home is within the next few years, don’t risk your down payment funds in the stock market just to speed things up. It’s all too easy to lose it, so stick with FDIC-insured deposit accounts.
Training for Home Ownership
OK, you’ve opened your money market account. Now what? Here’s a simple plan to getting started on that down payment. The key is to budget and save as if you were already paying a mortgage.
- Make a realistic estimate of your future mortgage payment. A lot of good mortgage calculators out there will give you an estimated monthly payment once you plug in a loan amount, loan term (put in 30 years if you’re not sure), and a mortgage rate. Include other recurring costs such as insurance and property taxes.
- Subtract what you are currently paying in rent.
- Deposit the difference into the money market account. Keep this up until you have the down payment to begin shopping in earnest for a mortgage.
Of course, save even more every month if you can, particularly if your rent payment is close to your estimated mortgage payment — but putting at least the difference in your money market account is a way of testing your discipline. If you can stick to this plan, you’ll be saving for your down payment and training yourself for mortgage payments as a homeowner at the same time.
Although having to save for a real down payment may make home ownership seem so much further out of reach than it was a few years ago, keep in mind that you’re doing yourself a huge financial favor in the long run.
Richard Barrington, CFA, is the personal finance expert for MoneyRates.com. He has earned the CFA designation and is a 20-year veteran of the financial industry, including having previously served for over a dozen years as a member of the Executive Committee of Manning & Napier Advisors, Inc. He has written extensively on investment topics, including investments, money market accounts, certificates of deposit, and personal finance as it relates to retirement and has been quoted by numerous media publications such as The New York Times, The Wall Street Journal, CNN Money, and Pensions & Investments magazine.