I recently received this question from a reader:
We are going to buy a first home sometime in the 2nd quarter. We have 12k saved for a down payment. Will it benefit us more (in regards to the mortgage financing terms) to pay down debt or add to the downpayment amount in the next 3-6 months? We will have about 3-5k available from our income in that time. We have no credit card debt and have about 9k left on a vehicle loan. If I'm not convinced one way or the other, I'll probably "split the baby" by paying half to each.
What suggestions do you have for him?
I would add to the down payment until you actually decide on a house. It's better to have more in reserve than you need when it comes time to close than it is to not have enough.
After you have a house, you can always use the excess to pay down the car loan.
With no credit card debt and a solid credit history, a $9K car loan is not going to make you appear to be a bad credit risk when it comes time to get a mortgage.
Posted by: | January 17, 2009 at 08:48 AM
First, does this person have an emergency fund established outside of this downpayment. If not, that get funded first. In fact, that needs to be in place before buying the house.
Next, if you single goal is the best mortgage terms, you need to have saved at least 20% of the purchase price in order to avoid PMI. You will continue to pay PMI until you have enough equity in the home to convince the lender to drop it. Given the falling home prices, you are likely to be stuck with that for some time.
Third, when buying a home, there are typical expenses that are never though of until closing. You will be paying out dollars for utility/other services activations, window treatments, paint, repairs, etc. that pop up on the day you move in. You need to have a few thousand extra set aside for the typical move in costs.
Lastly, given the monthly cash flow described above, you should be able to eliminate the car payment within 2-3 months. If it were me, I would be delaying the purchase of a home just to get this off the plate and free up more monthly cash flow. With continued falling home prices, you benefit both ways.
Posted by: JimL | January 17, 2009 at 08:51 AM
You need a 20% down payment on the home. Right now you have a down payment for a $60,000 house, if you can save another $4,000 you can have a down payment on a $100,000 house. If you can't put 20% down you may struggle to get good financing or financing at all.
If you don't have an emergency fund the money goes there until you have at least enough to cover 4 months of expenses. Which are about to increase when you buy a house.
If you have an emergency fund and the house costs more than $60,000 I would save the money toward the house. keeping in mind closing day you could have $2,000 in costs.
If you have an emergency found and know that the house costs less than $60,000 I would put half the amount toward the car (it will give you a buffer if you need to take a few months of paying it). After you are settled in the house and are back to saving money each month (the first few months of homeownership can be hard on the savings plan) I would asses whether to pay extra toward the car or mortgage.
Posted by: Meoip | January 17, 2009 at 09:40 AM
Unless, the car loan rate is sky high and you're losing a lot of money to interest, I don't see any reason to not just save cash. Then, when it comes time to buy, ask the actual mortgage co. you work with which would be better, if your debt is a problem, it only takes a day to put that cash toward the debt. Whatever you do, don't come out of the closing with a house and no cash. Life requires an emergency fund, life with a house and/or children requires a LARGE emergency fund.
Posted by: Strick | January 17, 2009 at 11:40 AM
The car loan doesn't matter unless you pay it off entirely. They will just assume you will buy another car with the same payments. The down payment doesn't matter unless you can break a threshold like 20% down. It is probably best just to keep the cash showing you have the flexibility to deal with unanticipated expenses. Do you also have the cash for closing costs, moving, repairs and upgrades, etc?
Posted by: Lord | January 17, 2009 at 12:17 PM
I'll second what others have said about putting down at least 20% down payment on your new home. Although rates are currently low the credit markets are still in really bad shape and good loans are incredibly hard to come by. If you're not ready to put down 20% you're going to have a *very* hard time finding a good loan or possibly any loan at all.
Have you talked with a mortgage lender yet? I'd recommend at least getting a pre-approval to see what you can safely spend and expect to get a loan for with your current finances and down payment expectations.
Posted by: Krazy Eyes | January 17, 2009 at 12:22 PM
This is simple. Pay off the car, now. Do not accumulate any more debt. Establish an emergencey fund equal to 3 to 6 months of your monthly income. Then start to accumulate a downpayment equal to 25 percent of the house value. Slow down. Patience--instead of instant gratification--will get you to where you need to be.
Posted by: Conrad Zutavern | January 17, 2009 at 02:27 PM
Just save the cash.
Interesting piece today in the NYT today about a disaster plan for your finances which advocates NOT trying to pay off debts quickly in a time of emergency, such as job loss. I know that isn't the purpose of this reader's question, but it makes sense to have as much flexibility as possible in any circumstance. Once the money is committed to either paying down debt or boosting the downpayment, it is not available for what's behind door #3.
Posted by: Catherine | January 17, 2009 at 03:33 PM
I am a real estate broker and also invest in real estate myself. I have been a young homwoner for ten years now (two different primary residences). Unless you are in a very low cost area, I don't think you have enough money to get started safely - by safely, I mean financially. You must consider the costs of major repairs on a home to keep it at or higher than the value you paid for it. You must have enough money set aside for when the central a/c unit goes out...you don't want to be stuck using a window unit, etc. As another poster said, take your time, save some more and then buy when you can pay off your car, put a large downpayment, have a general emergency fund and a general home maintenance fund. It will be worth the piece of mind to know you are in good shape and are in no way risking getting in over your head.
Posted by: ALB | January 17, 2009 at 04:22 PM
I would say add to the down payment. The more you can knock off your mortgage -- which will probably be your biggest piece of debt at the end of the day -- the better. Compounding interest over the life of a 15-30 year mortgage can add tens of thousands to what you actually pay ... much more than the debt you have in your car loan.
If, from the start, you can reduce the amount you owe on your mortgage, you might be able to save thousands in interest payments!
Posted by: Ruben G | January 17, 2009 at 08:09 PM
Add to your downpayment cash. Pay the car normally, when you are in your house then you can revisit whether or not to step up your car payments.
I have a two loan payments ending shortly, that is going to free up a fair amount of cash every month we can use to attack ugly debt and sooner or later step up mortgage payments.
Posted by: Mark Framness | January 17, 2009 at 10:22 PM
Add to your downpayment savings. If you don't have at least 20%, you'll be stuck paying PMI (very hard to get a split mortgage anymore)... and the closer you are to 20%, the sooner you can drop the PMI.
But make sure you also have a few thousand in savings for repairs/maintenance/closing costs. Those will add up more quickly than you can imagine.
Posted by: Anitra Smith | January 18, 2009 at 07:39 AM
It's pretty clear, they're not ready to be homeowners. In addition, what's the rush? Prices will continue to fall for quite a while, so save up some real money for the down payment ($12K? That's not even an emergency fund, let alone a down payment).
Posted by: Pop | January 18, 2009 at 12:15 PM
The bigger downpayment you have, the better chance you'll have of getting a loan. Lenders are being picky these days, as evidenced by this column: http://www.oregonlive.com/business/index.ssf/2009/01/refis_boom_but_gone_are_the_qu.html
Posted by: It's Only Money | January 19, 2009 at 02:56 AM
Add to your down payment if it will get you to the magic 20% mark to avoid PMI. I personally would pay off your other debt instead. Paying off all debt besides your mortgage will be a big benefit for your credit score and for opening up new money to fund other financial goals like retirement, college savings, etc.
Posted by: Hank | January 19, 2009 at 09:27 AM
I agree with the other commenters on all three counts - you need an emergency fund, you need a bigger down payment, and you really should get rid of that car payment.
One thing to consider is you're more likely to get a better deal on a house in the fall or winter than in the spring or summer. I don't know what your rental situation is, but if you could hold off for those extra six months, that should make a huge difference.
My husband and I bought our first home about four years ago with no down payment or emergency fund. We wish we would have waited to have those two things in place, first.
Posted by: Tarah | January 19, 2009 at 03:39 PM
As many comments have pointed out, put at least 20% down to avoid PMI. In light of today's low interest rates (maybe to go even lower), however, I question putting more than 20% down. A 20% down payment should be plenty to encourage mortgage brokers to offer you a good rate. Putting any extra money to work in an investment which returns more than your mortgage costs you is a better idea.
Posted by: Fidelity Select Fundranker | January 19, 2009 at 05:04 PM
To add to my previous post, here is a surefire way to invest extra money which will return more than your mortgage costs you: pay off higher interest debt like car loans and credit card debt. If you can handle some risk, here are some more ways to invest extra money which can return more than your mortgage costs you: invest in mutual funds, invest in Lending Club. On top of your extra money earning you a better return than your mortgage costs you, you also get to deduct your mortgage interest, which saves you even more money on your taxes. It's a win-win proposition.
Posted by: Fidelity Select Fundranker | January 20, 2009 at 10:12 AM
Seriously, "split the baby?" I don't know if that is a real phrase that people use. I get the reference, but it's kind of a gross metaphor.
Posted by: AdamCO | January 20, 2009 at 12:04 PM
Definitely on the right track, more so than many planning a first purchase. Two things...emergency fund and soft house prices. Emergency fund is not Not Negotiable, you must have it to rely on yourself first in a jam. Second, hunt down a property and get the best possible price, its a buyers mkt. Learn as much as possible about the area and what the real mkt is, you can buy yourself time getting the property for the lowest possible price. If they won't come to your price, within reason, WALK AWAY. Its possibly the cheapest, most powerful thing you can in the buying process! Good luck.
Posted by: tr | January 21, 2009 at 03:25 PM