For many years, the rule of thumb for first time homebuyers was to put 20% down when you bought your first house. Over the past decade we saw that rule pretty much fade away. Attracted by no money down loans, it was easy to qualify to get into a home that was likely to be several hundred thousand more in value than you could probably afford.
Many of the young families I talk to today are now struggling with those mortgages. Especially for those families who had a two spouse income household, and now they have had their very first child. With a new baby, one spouse’s income got cut down or expenses increased with things like day care.
So why bother putting 20% down on a house? Seems like a silly rule. Not at all.
Let’s say you were thinking that your first house was going to be in the range of $200,000. This means at 20% down, you would have to put $40,000 as a down payment on the home. If you saved over a 3 year period for this goal, you would have to put away around $1,111 a month for 36 months without earning any interest on the account.
Today, a $160,000 mortgage would carry a principal and interest payment of $880 at a 5.25% interest rate for a 30 year fixed note. If real estate taxes represented 1% home value, you would have another $166 of real estate taxes per month. Let’s assume home owners insurance would be roughly $42 a month on a $200,000 home. Thus, your total monthly payment would be around $1,088 per month.
We know that there are many other expenses that may occur when you own a home, but by saving 20% of whatever home value you are attempting to purchase you will actually put yourself in the habit of saving monthly what your mortgage payment will be. If you save the money in a quicker time frame than 36 months, you will likely be saving more than your monthly mortgage payment which will tell you what you may be able to handle for a payment.
You should always go through an exercise with a financial advisor and/or accountant before you buy a home to ensure you can afford it and know what your tax consequences will be. However, I’m a big fan of saving for something before your buy it . . . especially your first house. If you follow the 20% rule, it will generally keep the water out of your financial basement.
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oXYGen Financial, Inc. co-CEO Ted Jenkin is one of the foremost knowledgeable professionals in giving financial advice to the X and Y Generation.