Financial Makeover: Buying a First Home

ByABC News
February 14, 2003, 11:44 AM

Feb. 18 -- Q U E S T I O N: We would like to purchase a home but fear that we are living in an area of the country that is especially prone to the "real estate bubble" phenomena. We also want to start a family in three to five years. In addition, we need an investment plan. We pulled our money out of the stock market last year fearing additional losses and are invested in a money market fund.

Charlotte and Curt

Charlotte and Curt are trying to reconcile their desire to own their first home with a need to be smart about the timing. They are also concerned about developing a long-term investment plan without the fear of significant losses. They have a nest egg and are able to continue to save money monthly. How should they use their resources effectively to accomplish their goals?

Curt and Charlotte should first begin by analyzing how much house they can afford. Based on their current monthly rent of $1,500, an equivalent mortgage payment would be about $2,000, assuming a 28 percent income tax benefit. In this current low-interest rate environment, you can get a 30-year fixed mortgage for about 6.5 percent or less. If annual payments total $24,000, this amount would support a mortgage of about $370,000 (24,000/6.5 percent). Assuming a down payment of 20 percent, the value of the home would be approximately $460,000 ($370,000/80 percent). So, in this example, they would need about $100,000 for a 20 percent down payment and closing costs.

Curt and Charlotte may feel the task of saving an additional $60,000 over and above their current savings of $40,000 too daunting! But all may not be lost. There are some advantages to being a first-time homebuyer, including a reduction in the down payment from 20 percent to 5 percent. If they qualify, Curt and Charlottes have sufficient savings to purchase an approximately $400,000 house with $20,000 down. This would leave them with enough savings to cover the incremental costs of moving and have an additional "rainy day" emergency fund. (Remember, they would be financing 95 percent vs. 80 percent in the sample shown above, so an equivalent monthly mortgage would require a reduction in the cost of the home.)