The Truth About Down Payments
WHAT WILL YOUR LENDER NEED?
The first thing to determine when thinking about purchasing a home is how much you can actually afford. When it comes to home-related expenses, there are three transactions to think about: 1) the down payment for the home, 2) the monthly mortgage and 3) the upkeep that goes into maintaining your house.
DOWN PAYMENT: HOW MUCH DO I NEED TO SAVE?
We put down 5% on our home, which is the minimum that you can put down for a standard conventional loan at Community First Bank. Five percent of the home’s value plus the closing costs came out to approximately $24,000 (the full price of the home was approximately $380,000). With an FHA loan, you can put down as little as 3.5% with qualifying credit, but the downside of that option is that you will not have the ability to remove Primary Mortgage Insurance (PMI). PMI is typically removed at 80% loan-to-value, which is why most home buyers look to put down at least 20%. In my example, our mortgage is 95% loan-to-value because I only put down 5% on the home.
Loan-to-value: Your “loan to value ratio” (LTV) compares the size of your mortgage loan to the value of the home. If you paid a down payment of 20%, you are borrowing 80% of the home’s value, making your loan-to-value ratio 80%.
HOW WAS THIS AMOUNT CALCULATED?
The down payment is calculated as a percentage of the overall home value. This step is fairly straightforward once the bank knows how much house you can afford. Typically, the first step in the entire process is pre-qualification. In this step, you meet with a lender and go over your current financial situation. This process involves reviewing the prior year’s tax return, recent pay stubs, and current debt obligations to establish your debt-to-income ratio. As a safeguard against defaults on mortgage payments, banks do not typically loan money to individuals with a debt-to-income ratio of more than 40%. The absolute limit at Community First Bank tops out at 45%.
Example: If you made $10,000 monthly and you had $4,000 of monthly liability payments. $4,000 / $10,000 would equal 40% debt-to-income. It is at this stage that you can get a rough idea of the amount of monthly mortgage you can afford. In my case, we had sufficient monthly cash flow and low monthly liabilities, so our debt-to-income ratio was not a limiting factor. From there, we started to look at what we could afford for a down payment. Ideally, I would have liked to put down 10-20%, but the housing market in the Tri-Cities was rising too quickly for that to happen. We identified our price range and began to look at houses that fell within our budget.
The monthly cost of owning the home can be very expensive. Most mortgages are offered with a 15- or 30-year term. That is a long time to be paying for something. But what you need to keep in mind is that your mortgage payment will be a monthly expense until your home is fully paid for. For most families, their mortgage is the single biggest payment they have during any given month. There is a reason that banks conduct a thorough background check on your financials before they lend you a large sum of money. They want to make sure you are able to afford the monthly payments. Most guides recommend against spending more than 25% of your gross monthly income on your home, with 28% being the highest amount possible.
CREATING A SAVINGS PLAN
My wife, Joslyn, and I came up with our savings plan together after looking at our monthly income and expenses. From there, we picked a savings goal that we wanted to hit. During this time, I think the best thing I did was adjust my monthly payroll to automatically save the amount that I wanted. If there was a month that I overspent or wanted to spend more money on something, I had to go into my online banking and transfer money between accounts so that I could make the purchase. It was (and still is) a good checks and balances process that I have for myself. I also try to make sure that my checking account balance does not get too high to prevent unnecessary spending.
WHAT INFORMATION WAS CONSIDERED WHEN YOU APPLIED FOR YOUR LOAN?
- Current outstanding debts
- Credit scores
- Work history
- Current savings
- Prior year tax returns
- Prior year W-2s
- Current year paystubs
WERE THERE ANY PAIN POINTS THAT YOU HAD TO WORK ON?
I was thankful that we did not have any pain points or downfalls when it came to qualifying for a loan. Joslyn and I were both employed and had good credit history. However, one area we could improve was our credit utilization on our credit cards. Credit utilization measures the amount of available credit you are currently using. For instance, if you had a $2,000 credit limit and on any given month your outstanding balance is $1,000, then you have a credit utilization of 50%. It is encouraged to keep your credit utilization below 30% to improve your credit score. Many people think that credit utilization does not matter if they pay the balance down at the end of the month, but this is not the case. I would encourage everyone to check their credit card and bank balances at least three times a week. I like to check mine daily as a habit. This prevents me from overdrawing my accounts and provides me with a relative idea of where things are financially. It eliminates instances of overestimating your current financial situation.
HOW DID YOU SELECT YOUR LENDER?
Since I work at Community First Bank & HFG Trust, I let Joslyn pick the lender. She attended the Money, Myths, and Millennials event that we held during the summer of 2019. Derek Robinson was the mortgage lender that presented on the topic of starting the home buying process, and it was this presentation that made Joslyn feel that Derek would be the best fit for us. She was excited to go through the process of getting pre-qualified, which was the main portion of Derek’s presentation.
SHOULD YOU SHOP AROUND?
It is never a bad idea to see what is out there. Shopping for rates does take time, but this is a major purchase that happens only a handful of times throughout life. It is an interesting position being an employee of the bank. I did not feel pressured by the company to use their services, but I do like to use our products in order to gain a better understanding of the client experience. I do not want to make a recommendation to people out there without first trying it for myself.
After purchasing a house and living in it for almost a year now, I feel pretty good about my decision and the overall process, especially now that prices have continued to grow at a rapid rate. I will not downplay the fact that buying a house is very stressful. There is a lot of money involved, and you are dealing with things that are uncommon to most people. I think the biggest key to setting yourself up for success is finding people you can trust who will provide you with sound advice throughout the process, that includes your lenders and realtors. One thing that I cannot stress enough is to make sure that it is a good fit. The last thing that you want to do is rush into buying a house and to ultimately pay a large sum of money for something you do not truly want.
Wealth Planning Manager and Financial Advisor, HFG Trust
Bank products are offered through Community First Bank. NMLS #409021.
HFG Trust is a subsidiary of Community First Bank. Not FDIC insured. Not Bank Guaranteed. May lose value.