First-Time Home-Buyers: How Much Do You Really Need to Save?

Singles, couples, families -- at some point almost everyone turns their financial attention to buying a home. But how much do we really need to save the first time out? How much is enough to handle the typically steep curve of down payments and closing costs?

When it comes to saving for a home, there are some helpful rules of thumb. But then, there are also alternatives for buyers who need a leg up. Let's look at the basics and some workarounds when considering approaches that first-time buyers can take to getting through the front door of their first house.

Buying your new home: Savings and expectations
Most real-estate experts will tell you to have at least 5% of the cost of a house on hand in savings to account for the down payment. But that's only a minimum, and expectations can differ by community.

In a city like New York, for example, minimum down payments are almost always 20%. And even if you're able to secure a mortgage by putting down less than 20% of the selling price, you're almost certainly triggering mandatory mortgage insurance as a consequence. Mortgage insurance, however, doesn't have to be a major stumbling block.

• Mortgage insurance terms: In general, home buyers who pay less than 20% in their down payment have to pay mortgage insurance until their loan-to-value ratio is 80%. So, if you borrowed $270,000 on a $300,000 home -- in other words, your down payment came to 10% -- your LTV ratio (that is, the loan amount, $270,000, divided by the price of the house, $300,000) would be 90%. Your monthly payments on that policy would continue until you paid your mortgage down by another $30,000 to a balance of $240,000, or 80% of the full price.
• Mortgage insurance premiums: The amount of your mortgage insurance premium depends on your credit score and the size of your down payment. In many cases, when it comes to private loans, mortgage insurance runs in the 0.3%-1.15% range. In our previous example, your monthly insurance payment would be some $68-$259.

And so, on a 30-year mortgage, our homebuyer, given an excellent credit profile, would take on approximately $1,762 in monthly payments (at a 5% interest rate, including 78 mortgage insurance payments of about $113 at 0.5%, and blending property tax into the payments at 1.25%). That's based on an initial savings of $30,000, used as a down payment on a $300,000 house.

Note that if our home buyers had saved $60,000 for the down payment, their monthly bill would drop to some $1,600, eliminating the need for mortgage insurance. But in our model, mortgage insurance accounts for just $1,356 annually over 6.5 years in the $60,000-down-payment case -- or $8,800 total. Turns out that's a lot less than saving the additional $30,000 to hit the 20% down-payment mark. And so, if savings are an issue, first-time buyers might take on the insurance in exchange for a lower down payment.

Closing costs: First-time buyers beware
Closing costs typically include fees for commissions, appraisals, and surveying; inspections and certifications; tax and title services, government record changes, and transfer taxes. You'll also pay an origination fee to your mortgage lender, and a charge for specific interest rates.

Other factors can also come into play. In a major city co-op, you may be required to have a year or more of maintenance fees in the bank. And finally, remember that the tail end of every home buyers' experience is the move -- meaning even more bills.

First-time home-buyers are sometimes surprised when they see how closing costs can add up. The average amount is 3% to 6% of the price of the home. Given that range, it's a wise idea to start with 2%-2.5% of the total cost of the house, in savings, to account for closing costs. Thus our $300,000 first-time home buyer should sock away about $6,000-$7,500 to cover the back end of their buying experience. Tallying the recommended savings so far, the amount comes to $36,000-$37,500.

And don't leave out one all-important consideration: the home buyer's buffer.

To your initial savings for a $300,000 home, it's also wise to add enough to ensure that any unexpected twists and turns are accounted for after you move into your new house. A sensible goal is to think of that buffer as a half-year of mortgage payments. That would be $10,572 for the buyers in our initial $300,000-at-10% model -- a total of $46,572-$48,072 in the bank before closing a deal.

Home buyer alternatives for first-timers
If saving for a first home seems a hill too steep, take heart: Assistance programs can help. Starting with plans at the federal level, these can cut the initial savings needed by a dramatic amount.

• FHA loan: Depending on property location and other, personal factors, you could qualify for a home loan from the Federal Housing Administration. In most cases, you'd be expected to make a down payment of approximately 3.5% (with a 1.75% insurance premium, and at a 4.25% interest rate). A down payment on our $300,000 model: $10,500. Together with closing costs and a buffer, savings required would be $26,916-$28,416. Notice, however, that you're paying a great deal more than in the non-FHA model when it come to the higher mortgage-insurance premiums -- some $43,485 over 103 months. Still, the FHA plan may be more manageable for some, as the initial down payment is smaller and insurance payments are spread out.

• VA and USDA loans: Certain veterans, active members of the military, and qualifying residents of designated rural areas can qualify for a 0% down-payment housing loan -- mortgage-insurance free as well -- from the Veterans Administration or the U.S. Department of Agriculture. In this case, first-time home-buyers could walk into a $300,000 house for just the closing costs, plus the suggested six-month buffer.

What's clear is that home buyers have options, and while the savings required to get a first home can climb to the neighborhood of $50,000, they can also come in around the mid-twenties. There are also assistance plans available from Fannie Mae and Freddie Mac, featuring 3%-5% down payments, and each comes with it own pros and cons. First-time home-buyers should also look into state and local plans. The research you invest in your process ahead of time can greatly affect what you have to save up before turning the key to your new front door.