Saving for a New Home Purchase

2020 was an unprecedented year in recent memory to say the least. The pandemic drove a number of trends, including younger Americans storing away cash like never before and a white hot housing market. 

As older millennials started families amid the backdrop of the pandemic, demand has surged for younger families to get into their first home or upgrade to a larger space given the work from home trend that is becoming increasingly mainstream. 

The main worry with younger generations then is how to save for a home amid surging demand and prices. The fact is you should aim to put yourself in the best financial situation moving forward and from a cash flow optimization perspective, that can mean saving enough for a down payment to avoid additional costs. 

In fact the market has been so hot lately, that a number of homeowners are choosing to sell, take the equity, and opt to rent instead. It’s not completely surprising considering the dramatic price appreciation in home prices across the U.S. that some would-be buyers and current owners are actually opting to rent as things cool off even slightly. 

Despite these recent trends, whether permanent or temporary, here are some key factors to consider as you look to get into your first home. 

Consider The Cost of Private Mortgage Insurance (PMI)

One of the major considerations when deciding how much to save for your first home purchase is the need for Private Mortgage Insurance (PMI). Generally, the lender you work with will require PMI for down payments less than 20% of the home’s purchase value. 

If you are not able to put down at least 20% at the time of closing, the lender will require you to purchase PMI which varies, but typically ranges from 0.5% to 1.5% of the mortgage amount. Aim to put down as much cash as feasibly possible if a 20% down payment is out of reach to decrease the amount of PMI you will owe over time. The cost of PMI is inversely related to the down payment you put down, meaning the larger the down payment the less you will likely pay for PMI among other factors like home appreciation and credit score.  

It may be a large number to save for upfront, but the impact to your future cash flow can be significant over the long run. The price appreciation we have seen in home prices nationwide may be a barrier for putting down 20% to avoid PMI and other costs, but you can still save enough cash to put down a sizable amount if you plan ahead. 

Should I Consider Moving Back With Family or Getting a Roommate While I Save Up? 

It certainly depends on your individual situation, but having roommates or living with a family member can dramatically reduce monthly housing costs.

Especially for gen z and millennials a few years out of college, if you are single and living on a tight budget, having roommates can be a huge relief for your monthly cash flow. 

“Location, Location, Location.”

It should come as no surprise to anyone that location has a huge impact on the price of any home you are considering. If you are open to moving to a lower cost city, it can be a great way to dramatically reduce costs. 

I think we could see the trend of moving to a lower cost city continue to accelerate over the next decade. This is especially the case because of the flexibility of remote work. If you can make a similar pay, doing the same job, but in a much cheaper city from your laptop, why not consider making the move?

Of course, having a solid support system in place of friends or family is an important factor as well. 

What Should I Focus On 5 Years Out from Purchasing a Home? 

Five years out from buying a home, take stock of your finances and come up with a plan to tackle any outstanding debt. 

Working with a longer timeframe like 5 years is going to allow you to focus on some other priorities first, such as paying down high interest debt like car loans or credit cards, establishing an emergency fund of roughly 6 months worth of expenses, and focusing on other ways to free up cash flow. 

Once these items are addressed, you can start thinking about saving into your down payment fund. 

What Should I Focus On 2 Years Out from Purchasing a Home? 

Two years out from buying a home, you need to focus on how to free up as much cash flow as possible. 

After all, you will be taking on what will more than likely be the largest liability in your lifetime. With a mortgage on your balance sheet, you want to make sure you will be in a good financial position to handle the monthly payments, in good times and in bad. 

Bolster your emergency savings and tackle high interest debt if it’s still weighing down your monthly cash flow. By having a solid emergency fund in place, you will be putting yourself in a position to weather the storm while paying your mortgage, should you experience a job loss or you need to replace a major appliance in your new home. This is why funding your emergency fund and paying down debt comes first and foremost before you think about taking on a mortgage.

What Should I Focus On 1 Year Out from Purchasing a Home? 

A year out from buying a home, you want to have a fully funded emergency fund and have at least started your down payment fund. You should have a rough idea of where you want to live and in which neighborhoods, so you can estimate the costs associated with buying a home. 

Take an inventory of all the expenses including closing costs, working with a realtor, moving costs, and even the extra cost of fuel and travel from driving around and looking at properties. 

It may sound crazy in today’s hot market, but if you can, you should aim to put down at least 20% as a down payment to avoid the extra cost of Private Mortgage Insurance (PMI). 

Summary

The most important thing you can do when struggling to start saving for a down payment for a new home is to come up with a plan. It sounds simple enough, but until you have a clear direction of how you will accomplish the goal, you are likely to get discouraged or distracted along the way.

Home ownership can have a beneficial effect on your long-term financial independence, but if not done intentionally and in the right mindset, it can also be to your detriment.

Do not let a hot housing market force you into a state of FOMO and into a house you cannot afford or will regret buying 6 months down the road. The right time to get into a home is the time that works best for you, not what the market may or may not do in the next 12 months. 

As always, we are available to walk you through your major life purchases and advocate for you along the way. 

Before you take on any investment or retirement strategy, it is vital that you seek out proper investment and tax advice beforehand. Investment performance is never guaranteed and investments may lose some or all of their value. On top of that, there may be severe tax consequences if withdrawals are taken improperly and can have a significant impact on your portfolio and retirement. Although we provide Investment Advice and Personal Financial Planning Services, we at MWM do not provide tax advice and any tax advice should be rendered by a licensed tax professional such as a CPA.