As 2001 draws to a close, many people are thinking about their goals for the new year. One that's high on the list of cramped apartment dwellers across the nation: owning a home.
While exorbitant prices in some parts of the country make buying a home difficult, don't automatically assume it's out of reach. "People should understand that it's not impossible to buy a house," says W. Eric Hehman, a certified financial planner at Austin Asset Management in Austin, Texas. "If you can find a good mortgage broker, they can help you structure almost any kind of loan."
When it comes to saving money, financial planners say plain old money market accounts might be the best place to invest your house fund. Short-term CDs are an option -- sometimes they offer better rates -- but be aware that you may end up tapping into the money earlier than you think, and CDs typically impose early withdrawal penalties. "If you think you may need the money in three years, you may need it in a year-and-a-half," says Eileen Dorsey, a certified financial planner in St. Louis.
Meanwhile, alternatives like short-term bond funds could offer higher returns than money market funds, but they could also lose some of your principal. "I would not put money in anything where the principal fluctuates if you think you'll need it in the next 10 years," Dorsey says.
Bankrate.com provides yields on money market accounts around the country. Dorsey also recommends checking out the options at credit unions, which sometimes offer better yields than banks. As a general rule, she says, people in tax brackets of 28% and up are better off investing in tax-free money markets, while those who pay lower rates should stick to taxable accounts.
In any case, gaining a fraction of additional yield isn't really the point when you're saving for a house. "The talent isn't in picking the right fund, it's in watching your budget," says John Henry McDonald, a certified financial planner at Austin Asset Management. "The person who will have the most money at the end isn't going to be the person who had 1% greater return, it's going to be the one who has the extra job. The person who skips a few lunches, who brown-bags his lunches, is going to be the one who has the house first."
An automatic investment plan will ensure that money from every paycheck is set aside for your house fund. "Find out the dollar amount that makes you choke, then use that" as a benchmark to funnel into a house fund, says McDonald.
Tricks of the Trade for First-Time Homebuyers
But say you've already amassed a pot of house money, and you want to get started.
First off, financial planners suggest making as big a payment as you can afford. The bigger the down payment, the less money you have to borrow and the more you'll save in interest. Think of that saved money as an automatic return. Alternatively, if you choose to make a smaller down payment and invest the rest in the stock market, you'd risk losing some of your money.
If you can come up with a down payment of 20% of the home price, you'll also avoid paying private mortgage insurance (PMI) on conventional loans. Lenders typically require PMI to cover the risk of default when borrowers can't come up with a 20% down payment.
As a ballpark estimate for a $150,000 loan, the PMI might tack an extra $100 or more onto your monthly mortgage payment, depending on your lender and your credit score, Hehman says.
The Primary/Secondary Option
But even if you can't afford a hefty down payment, you still may be able to avoid paying PMI through an arrangement known as a primary/secondary loan. This allows you to put down as little as 5%. The rest of the payment is financed through a two-part loan in which you borrow 80% from the primary lender, 15% from the second. (There are variations on the theme, like putting 10% down, with an 80% loan and a 10% loan.) Typically, the secondary loan is more expensive, but it's likely to end up being cheaper than paying PMI.
Another advantage of the secondary loan is that you can deduct the interest on it, which you can't do with mortgage insurance. Later, if your home appreciates in value, you may be able to refinance at a lower rate and combine the two mortgages, essentially getting rid of the more expensive loan.
The actual terms of the loan will depend in large part on your credit score, based on data from credit reporting bureaus. The better your credit, the better the rate you'll be offered. According to the National Association of Mortgage Brokers, on a potential scale between 300 and 900, those with a score of 620 or more are eligible for the best-priced loans.
Obtaining a good rate is crucial because over time, small differences in interest rates can add up. Realty agency Re/Max points out that the difference in the monthly payment on a $100,000 mortgage at 8% vs. 7.5% is about $35 a month. Over 30 years, that amounts to $12,600.
If you want to give your credit score a last-minute boost, think about how to reduce your monthly obligations.
Pay Peter or Paul?
For example, say you have $3,000 available, and you want to improve your credit before you apply for a mortgage. You have a credit card balance of $3,000, with a minimum monthly payment of $30. You also owe $6,000 on a car, with a minimum monthly payment of $300. "If you put the $3,000 toward a credit card, you get rid of a $30 a month obligation. But that doesn't help you when
lenders consider your ratio of income to debt," Hehman says. "If you put $3,000 toward the car, you've freed up $300 of mortgage you could qualify for that you couldn't before."
Another tip: If you're within 10 payments of paying off a car payment, it won't count against you in applying for a mortgage, Hehman says. If you can afford to pay ahead to that extent, you might want to consider it.
When it comes to comparing mortgages, you'll want to know whether the rate offered is with or without points. Points represent interest you pay upfront, based on factors like your credit score and the size of your down payment. One point represents 1% of the loan, so a point on a $200,000 mortgage is equivalent to $2,000.
Advisers say that if you don't plan to own the house for more than five to seven years, you should try to avoid paying points, to keep your upfront costs as low as you can. Most people either refinance their homes or move within a five-year span.
Also, check on the various fees lenders require you to pay for loan origination, application, credit appraisal and so on, as well as closing costs.
And check with your own bank first for mortgage rates -- it may be able to offer you a deal. A good source for comparative rate shopping is Bankrate.com, which also offers phone numbers of lenders in different parts of the country. Plus, financial planners say mortgage brokers provide excellent service by doing the rate shopping for you. They make money through fees built into the loan. You can find them in the yellow pages.