What Should You Save for a Mortgage Down Payment? In this episode of “Ask the Hammer”, Robert Powell, editor of Retirement Daily on TheStreet and finStream Co-Founder, sought insights from Jeffrey Levine of Buckingham on the complexities surrounding home down payments, especially for first-time homebuyers.
The Question at Hand
A young couple in their late twenties is eager to dive into the world of homeownership. With hearsay suggesting the average down payment hovering around seven percent for first-time homebuyers, the question is whether they should follow this route or aim higher to potentially lower their monthly mortgage payment.
While the premise might seem simple, the answer, as Levine highlights, isn’t straightforward. “It depends,” he started, underscoring that the answer lies intertwined with multiple considerations:
- Alternative Uses of Money: Before finalizing a down payment amount, Levine advises couples to contemplate the other potential uses for that money. For instance, if accumulating a more substantial down payment means delaying the purchase of one’s dream house, is it worth the wait?
- Bank Benefits: A more substantial down payment can sometimes translate to reduced monthly payments and might even help in lowering the interest rate. With more equity in the home, banks perceive the deal as less risky. This perception can sometimes make certain loans available that wouldn’t be with smaller down payments.
- Current Interest Rates: The decision is also influenced by the prevailing interest rates. When rates are low, a smaller down payment might suffice as homeowners can potentially earn better returns on their money elsewhere. Conversely, as interest rates rise, making a more considerable down payment becomes more financially sensible.
- Home as an abode, not an Investment: Emphasizing the emotional aspect of a home, Levine says, “a home is where you live,” urging potential buyers not to treat it solely as an investment. The financials should be weighed, but the emotional and life-quality aspects should be the primary drivers.
Budgeting for a Home Purchase
On being queried about an ideal budget allocation towards housing expenses, Levine drew attention to two key metrics: the front end ratio (encompassing principal, interest, taxes, insurance) and the back end ratio (incorporating other types of debt). While lenders might have standard guidelines based on these metrics, Levine emphasizes the importance of understanding personal lifestyle needs. Every individual might have unique financial responsibilities that don’t manifest as ‘debt’ but do impact monthly cash flows.
Moreover, Levine warns about underestimating home-related expenses. From utility bills to maintenance costs, homeowners often find their actual expenditures overshooting initial estimates. With the current fluctuation in interest rates, this unpredictability only intensifies.
Purchasing a home, especially for the first time, can be an emotional roller coaster. While financial considerations are undeniably crucial, it’s equally vital to prioritize the value of memories and experiences that a home can host. As Levine concluded, the right balance between financial practicality and emotional significance is the key to a rewarding home-buying journey.
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