During my previous post, we did a couple of exercises around calculating how much house you can afford and what your approximate timeline to buy will be. By targeting when you want to put an offer in on a new home and close (take over ownership) on your new home, you can then calculate some other key steps and milestones. One of the key numbers in the above calculations was around the down-payment which impacts a lot of the financial aspects of the mortgage. But what we didn’t talk about specifically, was how you were going to pull together that down-payment. It’s one of the biggest steps you need to take financially, and actually, well before you start the home buying process.
For the basics, let’s just assume you need 5% to 20% down-payment for a $300k home. That means you’ll need to save $15k to $60k for a down-payment which can be a significant amount of money for many people. There are some cases for FHA loans where you can put down as little as 3.5% but in general, the days of low down-payment loans are limited after the real estate driven recession in 2008. Also in addition to the down-payment, you’ll need to cover closing costs (loan origination fees, inspection, title search, escrow for taxes and property insurance) of your new home which I’d roughly calculate as $5k to $10k for a starter home. So now you need to save $20k to $65k minimum, to start the home search in earnest.
As a first-time buyer who’s currently renting or living with family, the scenario is pretty simple. Come up with that down-payment money by hook or by crook! Cut down on the lattes or take on a side-gig to save up your money. Note that if your down-payment is a gift from a family member, oftentimes the mortgage application will ask that question since they want to know how financially disciplined you are. Also be aware that your offer-bid on a house will have an advantage as a non-contingent offer!
Now if you’re a current home-owner, it gets a lot trickier. Do you sell first or buy first? Selling first means that once you’ve accepted an offer, the pressure is on to find your new home. You’ll also likely have to find living arrangements while you’re in between houses unless you can time things perfectly. But you will have the equity/money from the sale of your house to fund the down-payment of your future home.
If you buy first and then sell your home, you’re under pressure to do two things. One, come up with the down-payment without the proceeds of selling your existing home. And two, you’ll be under pressure to sell your home quickly to minimize the amount of time you may have to carry TWO mortgages. But you will be able to make one physical move from your old home to your new home and eliminate a temporary stop and move in-between. I have known some friends who wanted a couple of months to move and were prepared to carry two mortgages for that period of time!
What you do is up to your preferences, your local real estate market and of course, your financial situation. But you should have a plan on when your house will need to go on the market, based upon your target purchase period as mentioned in the previous post.
Going back to the $20k to $65k down-payment and closing cost monies you will need, here are the options I’m aware of.
- Have the money in a banking account as cash, whether saved or as a gift.
- Pull the money out from an investment account like a Roth IRA or stock-trading account. The Roth IRA allows for a one time withdrawal ($10k) with no penalties for a first-time home-buyer. Could you pull money out of a 401k? Yes but it’s probably not recommended due to taxes.
- Use the money from the proceeds of your home sale for a down-payment. This assumes sell first, buy second. And hopefully you have enough equity to cover the entire down-payment or can raid your bank account for the difference.
- Take a short term loan from your 401k or home equity loan (HELOC) to fund the down-payment. You will be responsible for some interest while the loan is outstanding but this scenario works for a buy first, sell second process. You pay off the HELOC and interest when you sell your existing home.
Note that you will initially need some of that down-payment money in your checking account for an accepted offer as due diligence and earnest money. The rest/balance of the down-payment will be needed 4 to 8 weeks later when you close and take over ownership of your new home. Next up, we’ll talk about choosing a mortgage and getting a pre-approval. Much later on we will discuss due diligence and earnest money as part of the process around submitting an offer. As you can see, there’s a logical path and order for each step of the home buying and selling process and a LOT of dependencies between steps. So glad you’re here and learning the basics around this complicated life decision!