Are you on the prowl for your dream property? If you are, then you know that it's way too easy to get caught up in credit scores when considering a home purchase. But as banks and lenders continue to loosen requirements, the need to have money in the bank doesn't get any less serious. Getting prescriptive about how much you need in savings to satisfy a mortgage lender is tough business. Trust us, we know from our experience trying to assist our clients doing just that. That's the whole rhyme and reason we're writing this: to let you know first and foremost what you need to get a step closer to that perfect piece of property. Basically, the answer can depend on a host of factors, from the type of mortgage and size of the loan to the property itself and more.
First off, you'll most likely need a solid chunk of change upfront to cover a down payment and closing costs. Lenders might also want to see a stockpile of "reserves," which often translates to a certain number of months' worth of mortgage payments. Typically, three to six months' worth is enough. The bottom line is that it's tough to talk specifics about your bottom line. That's why it's important to get a solid understanding of your mortgage options and seek clear guidance from mortgage advisors; they will be the only ones to determine how much "reserves" you should have before presenting a loan.
Credit scores are critical, but so are income and assets when you're applying for a home loan. Here are some of the important savings you'll need to accumulate first:
Down Payment Needs: Down payments are inescapable for the vast majority of non-cash homebuyers. Outside of state or local programs, only government-backed VA and USDA rural development home loans allow qualified borrowers to purchase with no money down. Conventional and FHA loans typically require minimum down payments of 5 percent and 3.5 percent, respectively. On a $200,000 mortgage, that's $10,000 for conventional and $7,000 down for FHA. But beware: buyers often require even more in the preliminary negotiations. Haggle them down.
Conventional borrowers, as data from Ellie Mae and FHA have shown, put down an average of 20% towards the property. Existing homeowners often have an advantage because they're able to put the proceeds of a home sale toward a new purchase. Honestly, it can take first-time buyers years to scrape together enough money for a down payment. That's partly why nationally, home sales among first-time buyers hit their lowest point last month, as more and more individuals (and families) are capping off this year as a 'rental year' and postponing buying until early of next year.
Reserves: Paying the upfront costs of homebuying represents one pool of money. Lenders want to make sure you've got plenty left over to keep the monthly payments rolling in long after closing day.
One way they hedge risk is by requiring a certain amount of reserves. Guidelines can vary by lender, loan type and borrower. One month of reserves is usually equal to your monthly mortgage payment, including property taxes and insurance. Conventional lenders typically seek from two to six months of reserves, but it could be as many as a year's worth, depending on your risk factors.
Neither FHA nor VA loans have a reserve requirement for single-family homes. But purchasing multi-unit properties under these programs typically requires three to six months' worth of reserves. Reserve requirements will also vary for larger 'jumbo' loans.
A healthy amount of reserves can help homebuyers on the edge. Lenders can consider these assets as a positive compensating factor, which can help a spotty loan file overcome credit or debt issues and help the mortgage process move along faster.
Residual Income: Lenders will take a close look at the ratio of your major monthly debts against your gross monthly income. This is known as debt-to-income (DTI) ratio, and different loan programs have different requirements. Money-wise, it's not just the income stream some borrowers need to worry about.
Some lenders and loan types may require you to have a certain amount of money left over each month after paying major expenses. The VA loan program has pioneered this requirement, known as residual income. VA borrowers must meet a monthly residual income benchmark that can vary based on where you live and your family size.
For example, a family of five in the Northeast needs at least $1,062 left over each month after paying those major bills (think mortgage, student loan, child care). The FHA recently adopted the VA's residual income requirement as a test for borrowers with higher debt-to-income ratios. The change takes effect in late April.
Residual income doesn't necessarily represent funds you need to earmark for savings. But knowing how to budget and save are key traits of successful homeowners. While you save for a home loan, it's important to make sure you're maintaining or building good credit so you can qualify for the best rate possible. You can pull free credit reports every year from each of the major credit reporting agencies to see your full credit history. Also, the Credit Report Card is a free tool that gives you two of your credit scores and a breakdown of what's impacting your scores.
So there you have it - all the tools and tips you'll need in advance to plan out your property purchase! It might not be as soon as you expected it to be, but it's always better to have a dose of reality than to slip into a dream that will never be.