3 Things You Must Know To Save Money (And Grief) Before Buying A House
This post may contain affiliate links
Buying a house is the biggest expense you will ever have. Not only thousand of dollars, but hundreds of thousands. Unless you live in a small town, it’s very unlikely you can find something under $150,000, for a condo, more likely well over $200,000 for a single family home. In many cities the cost of the average home is over $400,000
I was totally clueless when I bought my first house. I was lucky. The price of houses then was not what it is today and I used some inheritance money to have more than the 20% downpayment.
Fast forward a few years and I made huge mistakes when buying another house. Check this previous post on the subject of big money mistakes. I made a bad decision and unfortunately neither the real estate agent nor the lending institution gave me advice.
Hopefully I can save you some grief. Here are my top 3 recommendations for when you buy a house.
PROJECT: BUY HOUSE 101
Have at least 20% as a down payment.
- This will save you paying the lender’s mortgage insurance (LMI), an amount that is added to your mortgage – and amortized over years, with interest. Yes you could pay it in advance, but why not put that extra 2.8 to 4.% (at least $9,000 or so on a $300,000 home) on the down payment.
This will not only save you from paying the insurance, plus interest on the insurance but will also reduce your monthly payments. Yes you will pay interest for the length of your mortgage on that insurance, so it will probably cost you over $10,000 in interests) Ouch! Ouch!
I know it’s not easy to save that kind of money. But if saving load of money is important for you, then do everything you can to succeed. Live in smaller quarters, share an apartment, live frugally, postpone buying a car. Remember why you are saving and how much money a sacrifice today will save you tomorrow.
Make extra payments
- You know that money you save by having 20% down and saving the cost of the insurance+ interests on said insurance? You can now put that money aside and either add it to your monthly payments or once a year make an extra payment that will go directly to lowering the principal you owe. Because, as you may have seen if you looked at a mortgage amortization graph, the first few years of mortgage payments go mainly to paying the interest, with a few dollars only to the principal. If your mortgage is $100,000 , at 6.5% over 30 years, total payment $632., your first payment would go mostly to paying interest ($541.) and $90. toward reducing the amount borrowed. When you make your last payment, about $3.00 remains on the interest to be paid and $540 will go to the amount borrowed.
Bottom line: it pays to increase your monthly payment by a few dollars or make an extra payment a year – in this example, increasing the monthly payments by about $70. can save you $50,000 in interest – that’s big money – because it would shorten the term of your mortgage from 30 years to 23.
If your bank does not allow larger monthly payments, most lenders allow you to make an extra payment every year on the anniversary date. This will also save you tens of thousands of dollars. If your house cost 3 times the example I used, then you can save 3 times as much with extra payments.
Even if the interest you pay on the mortgage is deductible, up to a certain amount, it is not as good as not spending the money to start with. Keeping the money in your pocket is better than getting a deduction after you spend it.
Don’t buy mortgage insurance, buy this instead
Finally, don’t buy mortgage insurance. Yes you need insurance to cover the mortgage should you or your spouse die, but mortgage insurance is not the way to go because the amount that is insured goes down as you pay down the mortgage but the payments remain the same. Declining benefits and possibly higher premiums.
Mortgage insurance premiums are usually higher than those for life insurance – all other things being equal – and not only that, if you change lender you will need to take a new policy, at a higher premium, because you are now older, and if you have health issues, you can be refused or charged such high premiums that it may not be possible for you to proceed with the purchase of the house.
A better alternative is to buy term life insurance. A term life insurance is portable and will remain in force if you switch lenders or sell the present house and buy another. This insurance will pay out the full amount whether the insured dies in the first year or in the 27th year. If you buy term life insurance, once you are accepted and have disclosed any health issue you may have, you are in. Most terms will cover you until age 65 without a hike in premiums
A final warning about mortgage insurance sold by your bank. There have been horror stories when the bank refused to pay because they do the underwriting (looking at whether you qualify or not) at claim time. Any small error on that quick at the bank application form and you are toast, or your family is if you are the dead one.
Finally, last but really first to do before home buying: educate yourself. The state or province where you live may have different laws that affect borrowing, interest, taxes, etc. Go speak with your bank, or better talk to a mortgage broker (they get you the best rates), speak to an insurance agent and ask questions until you are clear that you understand the implications for each choice, read about the different kinds of mortgage – open vs closed, fixed vs variable – Don’t be intimidated into buying any kind of product, or house. Wait until you are ready and feel confident with your choices. Related reading
Remember that those who want to make money either selling you a house or lending you money don’t necessarily have your best interest at heart. Do your homework.