Channeling your savings towards buying a home

If your 2 a.m. Zillow scrolling binge made you feel like you should have bought a house yesterday, the thought of waiting to buy could be nerve-wracking. Alas, thanks to the housing affordability crisis and low supply, the path to becoming a homeowner has become quite daunting. So how should you use your money to get those keys ASAP?

Unfortunately, there are no real shortcuts, but you can at least start by answering these questions:

What is your deadline?

The sooner you want to buy, the more money you will need, and sooner. And people who feel like they need more money in the short term sometimes jump headfirst into big, fast returns on investments (like crypto, options, etc.). While it’s not impossible getting lucky doing this and making a (big) quick buck is not likely…and therefore not a smart move. 🤡

If your time horizon is short, put your savings somewhere safe and ignore the sexy lack of potential ROI for now. High-yield savings accounts are great for storing money you’ll need in a year’s time, CDs can get you a higher return if you’re willing to tie the money up for a while, and I bonds can be a great way to keep up. with inflation (although you can only put in a maximum of $10,000 per person).

A diversified portfolio in a medium asset allocation, like 60/40 stocks/bonds, can help your money work a little harder for you when you have the time and risk tolerance to stay the course. On top of that, using a robo-advisor can take the guesswork out of managing your investments for a low fee.

What about your other assets?

The temptation is hard to resist. If you want to amortize your personal fund with money or investments from other places (like a savings account for other purposes or your other retirement vehicles), know that this is not a good idea to do so only under certain circumstances.

Let’s focus on the money you have. Some of them can be for fun things like vacations or to redo a botched tattoo (OK, maybe that one isn’t so fun). But if you’re okay with taking a vacation on your front porch and having another bikini season with your ex’s name on your hip, then those sinking fund balances and your future contributions to those funds are fair game. for your home purchase.

But your emergency fund? Off-limits ! Not only do you need it to keep you afloat if something bad happens, but your potential lender may also require you to have cash reserves (because in a way, by covering your butt, you’re also covering the butt of your bank).

Using retirement savings to buy a home can also be tricky. The IRS agrees with you using $10,000 from your IRA for a first home purchase and will even waive the 10% penalty it normally charges for early withdrawals. And if the money comes from a Roth IRA, you won’t have to pay income taxes either (remember: you paid them when you invested the money). But be careful with this option, because having less retirement funds is bad news for you and you might have to sell during a bear market to access the money.

Workplace retirement accounts are less helpful when buying a home. You box borrow up to $50,000 or half of what’s in your 401(k) (whichever is less). But not all plans allow it, and you will always have to hand it over sooner or later to avoid the early withdrawal penalty.

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You can also withdraw this money and avoid the penalty, but you will have to convince your employer that it is a hardship withdrawal. A slight warning: if you’re having trouble requesting a PTO, this might not be an easy question.

What is your housing budget?

Don’t be surprised if this question makes you change your answer to “What is your time period?”

Assuming you’re not buying with cash, what really matters are your potential monthly costs beyond just the mortgage. You also have taxes, HOA fees and home insurance to pay along with other pesky maintenance costs.

According to traditional personal finance advice (😴), you should aim to spend 30% of your monthly income on housing. Note that whether or not it is feasible depends entirely on where you want to buy.

Mortgage lenders generally want to see a maximum debt to income ratio (DTI) of 43%, but 36% is usually the magic number. So, you might be given the green light to exceed that 30% rule of thumb.

As a reminder, your DTI includes all of your minimum monthly debt payments like credit cards, car payments, and student loans. If your DTI is already high without a mortgage payment, you’ll need to focus on increasing your income or reducing your existing debt (especially if you’re facing high interest rates on one of these).

Here’s one way to make it more tangible:

  • Write down your existing debt payments and what you pay in rent.
  • Imagine your rent is a mortgage payment and add up all your debt payments.
  • Go to a DTI calculator and plug this figure in with your gross income (before taxes). This will show you if you might qualify for a mortgage with a monthly payment equal to your rent.

Once you have those numbers, ask yourself whether or not you’re willing to pay even more for a mortgage. How much more? Would you still have a decent DTI ratio?

All of this will give you a general range of what you could theoretically afford in monthly costs. And with that knowledge comes…another calculator!

Access this mortgage calculator and plug in the current average mortgage interest rate, loan type, a ballpark figure for house prices in your potential area, and enough for a 20% down payment (we’ll cover that more in a second) .

How did you do? If the calculator gave you a monthly payment within the range you found earlier, that’s amazing! For those who got a less than desirable number, keep playing with it. Could a smaller house or a cheaper neighborhood do the trick? Can you reassess your income and other debts?

For some, the down payment will still seem out of reach depending on your temporary horizon, so you’ll have to wait longer to be able to invest your savings more aggressively, buy a cheaper home, or put down less than 20% down. A lower down payment is quite an option! However, your mortgage payment is bound to be higher because there are more loans to pay off, and you will likely also have to deal with private mortgage insurance.

At the end of the line

Buying a home can be an uphill battle, even in the flattest places (I’m looking at you, Florida 👀). Saving in the right way based on your schedule and goals is one thing, but knowing what you can afford and what funds you have is a whole other beast. I guess it’s time to sober up. 😔—Myriam

About Teresa G. Wilson

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