By Peter Miller
Saving for a new home has just become easier. Both Fannie Mae and Freddie Mac say they will now buy mortgages with as little as 3% down, a big drop from the old 5% minimum.
Even though conforming loans are now easier to get because down payment requirements have been reduced, there’s still the matter of saving not only for a down payment but also for closing costs and a reserve fund for the inevitable repairs and other expenses that come with home ownership.
Saving so much money may seem like a huge hurdle, but last year roughly 1.4 million buyers bought their first home — people who purchased without any equity from past homeownership.
The Savings Shortage
It used to be that America was a land of savers. In 1975 the savings rate hit 15% in the second quarter. Now things are different — we finished last year with a scant 4.7% savings rate.
Saving is very practical when income exceeds spending, but in recent years there has been less income for most and thus less opportunity to save. Figures from the Census Bureau show that, corrected for inflation, in 2013 household income was 8.7% lower than in 1999.
Money in 1999 bought a lot more than it does today. The problem is inflation. The Bureau of Labor Statistics estimates that it takes $140 to buy the same bundle of goods and services that cost just $100 in 1999.
Combine lower incomes with higher costs and the decline in savings becomes inevitable. It used to be that about 40% of the people buying existing homes were first-time buyers, but now we’re down to about 29% — in large measure because it’s simply hard to save money for a down payment.
Hard, but not impossible — think about last year’s 1.4 million first-time buyers.
Strategies for Saving Up a Down Payment
Unless you’re related to the rich and famous, and unless the rich and famous feel especially generous, the odds are that you will have to largely cobble together money on your own to save for a house. On one hand this is a difficult task, while on the other saving money can be a real accomplishment, one with goals and a real prize for success.
So, how can you bulk up your savings? Here are the important steps to take.
Open A Savings Account
Open a savings account online or at the same bank or credit union where you now do your checking. The reason to use one institution is convenience: Most banks and credit unions allow you to transfer funds back and forth from accounts electronically and instantaneously. That means you can move money into savings from your checking account without visiting a branch or taking much time from your day — and you want socking away savings to be as easy as possible.
Start a Budget
Every company has a budget, and so should you.
The easy way to establish a budget is to use a spreadsheet — show your monthly gross income and then subtract taxes and other costs from your pay stub. This will give you your net income after taxes. Next, show what you pay for other monthly costs such as rent, student loans, car payments, and credit card bills. Subtract these costs from your net income.
Now comes the fun part. How much money is left each month — and how do you spend it? Start keeping receipts for such things as gasoline, utilities, restaurants, entertainment, parking, and other things you spend money on.
In very short order you’ll be able to see how much you take in — and how much goes out. Now you can ask the magic question: Where can costs be cut?
Given that income and expenses are closely matched in many households, the only way to get ahead is to bring in more money or change your spending habits (meaning spend less) and avidly look for new savings sources.
This may seem difficult, but it’s a reality that every household can save more. We know this because no matter how much you earn there are people with smaller paychecks who live in your neighborhood and yet live more or less like you do.
To create savings you have to be ruthless. Set a time to review your spending and budget, say the first and third Mondays of every month. Go through the numbers with zeal, asking if every nickel and dime was justified.
Check Interest Rates
Interest rates differ for such things as credit cards, savings accounts, car loans, and other accounts. Go through every bill and account and check the interest rate. Can you do better?
For instance, if you’ve been making full and prompt credit card payments, call up the credit card company and tell them you want a lower rate. You might get a lower rate simply by asking.
Auto loans are different. If you have a car loan with simple interest, then it can make sense to prepay the debt. However, many auto loans use a special “sum-of-the-digits” interest calculation, which makes prepayments less attractive as well as virtually impossible to understand.
How do auto lenders get away with such tactics? Easy. While mortgage lenders have lots of rules and standards under Wall Street Reform, auto lenders are specifically exempted from the rules with what in Washington is called a legislative “carve out” — a fancy term meaning auto lobbyists succeeded in getting auto loans excluded from the regulations. Auto borrowers, of course, have no lobbyists.
Should you sell your current vehicle and get a cheaper used one? That’s not always feasible given trade-in values and sum-of-the-digits financing, but run the numbers and always consider safety first. Meanwhile, when you next get a car, make sure it’s financed with simple interest and has a strong warranty that will cover repairs even if you move. Also, if you have savings, you can put more money down and qualify for a lower rate — still another reason to bulk up your savings accounts.
Check Your Credit
Your ability to borrow — and the rate you pay — are closely dependent on your credit score. Lenders might be very willing to originate a mortgage for you with little down and less savings if you have strong credit.
Your credit score is based on the credit reports, electronic files which show such things as where you have credit accounts, how much you have borrowed, your total debt, any missed or late payments, and how much more you can borrow with existing accounts.
“The key to the system is the assumption that credit reports are accurate, but that’s not always the case,” said Rick Sharga, executive vice president at Auction.com. “Sometimes credit reports are wrong, and when that happens your credit standing can be demolished. The result will be either higher borrowing costs or maybe no mortgage or auto loan at all.”
According to the Federal Trade Commission about 20% of all credit reports have errors. Five percent have mistakes that can drop scores by 25 points. That’s enough to move marginal borrowers into lower credit categories and higher rates.
Even worse, one report in every 250 has so many errors and blunders that the borrower’s score is actually off at least 100 points. That’s enough to sink a lot of mortgage applications and move your credit status from gold to tin.
Part of the problem comes from the vast number of reportable credit transactions which occur every year plus the potential for error: It can happen that the report for “Kenny Smith” may well include dings from “Ken E. Smith.”
The only solution is to check your report for factual errors and out-of-date items several months before you apply for a mortgage or car loan — enough time to clean up errors and disputes.
It’s great to save by spending less, but there’s also another source of savings — those occasional events that bring extra money into the household. Think of birthdays, bonuses, tax refunds, and — ding, ding, ding — the biggest winner of them all, weddings.
While it can be tempting to splurge a bit with these periodic windfalls, this is money that can be used to increase your savings account quickly without dipping into regular income.
Loan programs, especially loans insured by the FHA, want down payment money to come directly from borrowers to demonstrate financial responsibility and an ability to save. Because loan programs make a distinction between down payment money and other dollars – say a “seller contribution” used to pay closing costs – it’s very important to get as much down payment cash as you can.
There are two huge exceptions to the down-payment-only-from-you requirement: First, gifts from parents, relatives and friends are generally welcome. To be recognized as a “gift,” the donor will have to sign a gift letter saying there’s no expectation of repayment, interest, or anything else.
Second, there are many programs — roughly 2,300 nationwide — designed to help people buy homes, especially first-time buyers. Some of these programs offer outright grants which need not be repaid, while others offer interest reductions and tax benefits.
When looking at downpayment assistance programs use caution: Ask how long you must own the property before you can keep the profit from a sale.
If being a first-time buyer does not seem to fit your situation, consider this: In many programs, a first-time buyer is defined as someone who has not been an owner during the last three years or does not own as a result of divorce. In effect, it’s possible to be a first-time buyer even if you’ve owned a house before. For details and information speak with brokers and lenders in your community.
Peter G. Miller is a nationally syndicated real estate columnist. His books, published originally by Harper & Row, have sold more than 300,000 copies. He blogs at OurBroker.com and contributes to such leading sites as RealtyTrac.com, the Huffington Post, and Auction.com. Miller has spoken before such groups as the National Association of Realtors and the Association of Real Estate License Law Officials.