Question: My wife and I would like to buy a house in the next 12 months and have about $1,000 extra a month to either save for a down payment or pay off our existing debt. The houses we're looking at are roughly in the $175,000 range and we have about $11,500 saved already. We also have about $35,000 in student loans, car loans and credit card debt. We could put a real dent in the debt with this money, but I also feel that if we save for a down payment, our interest rate and monthly payments would be lower. What's your suggestion?
Answer: You're right on all counts, and what you should do depends a lot on the specifics of your situation.
Your savings now equal about 6% of your target home price. If you saved an additional $12,000, says mortgage expert Allen Bond, that would boost you well above the 10% mark. If you can make a down payment of at least 10%, you usually qualify for either a smaller private mortgage insurance payment or a lower rate if you're doing what's known as a piggyback loan--a regular 80% mortgage plus another loan for the additional 10%, says Bond, president of the California Assn. of Mortgage Brokers' Southern California chapter.
Private mortgage insurance, if you don't already know, usually is required by lenders when the borrower's down payment is less than 20% of the purchase price. Costs for the insurance vary, but it's usually $30 to $80 a month. You can avoid PMI by using a piggyback loan, although the interest rate on the second, smaller mortgage may be higher than the one on your first mortgage.
You may, however, be carrying so much debt that it's negatively affecting your credit score--which could increase your borrowing costs. You didn't give a breakdown of your debts, but if most of it is credit cards and car loans, rather than student loans, your score could be suffering. In that case, it makes sense to pay off the credit cards, at least, before adding to your down payment.
You can find out your credit score, and what's influencing it, by visiting www.myfico.com. For $12.95, you can view your credit report, your three-digit score and an explanation of the positive and negative factors affecting your score. You also can see, on the site's home page, how different scores alter the mortgage rates you can expect. Recently, the mortgage chart showed that someone with a score above 720 could expect a rate of 6.75%, while a score of 675 would move the rate up to 7.41%.
The site has a calculator to show how much you could save on a mortgage by boosting your credit score. You may discover the savings are so minor that you'll get more bang for your buck by saving money for the down payment, rather than using it to pay off debt. Or you may discover that a big jump in your credit score would be worth having a smaller down payment.
The site also has a simulator that allows you to "play" with your score. In other words, you can see how paying down your various debts might help your rating. (You also can see how far you can drive your score down with late payments, maxing out your credit cards, opening new credit accounts or declaring bankruptcy.)
Once you've done this homework, you'd be smart to find a good mortgage broker to discuss strategy, help you crunch all the numbers and get you pre-qualified for a loan. Good luck!
Cashing In Bonds to Pay Off Debt
Q: Recently we checked the value of our savings bonds and learned they are worth about $14,500, minus applicable taxes. We have an outstanding balance of about $13,000 on our credit cards, with an interest rate of 10.5%. We are thinking of cashing in the bonds to pay off the debt, and putting what we had been paying toward the cards into our savings instead. Is this a good move? If so, how shall we invest the money that's freed up when we pay off the debt?
A: Your plan gets a gold star. It almost never makes sense to keep money in low-yielding savings or non-retirement investment accounts when you're carrying credit card debt.
Once the debt is paid off, however, don't rest on your laurels. It's easy to slip back into a lifestyle where you charge too much and can't pay off your credit cards each month. Consider investing some of your savings in a community college class on budgeting and money management. If you prefer do-it-yourself study, you'll find plenty of good books on the same topics, including Eric Tyson's "Personal Finance for Dummies." Personal finance software, such as Intuit's Quicken 2002 and Microsoft's Money 2002, can help you organize and track your finances.
What you should do after that depends on your situation. If you don't have an emergency fund equal to three to six months' expenses tucked away in a money market fund, that's a good first goal. Once that's taken care of, see whether you can invest a little more in your employer's 401(k) plan or contribute to a Roth IRA. After you've maximized your retirement savings, you can consider other goals, such as saving for a new car or a long-desired vacation.
Investing is all about setting goals, making choices and matching your investments to your time horizon. In other words, money you may need within a few years--such as an emergency fund--should be kept in liquid accounts such as a money market. Money you won't need for 10 years or more, such as your retirement funds, can be invested in the stock market. Once you've set your goals for this extra cash, you'll be better able to determine how to invest it.
Liz Pulliam Weston is a contributor to The Times and a graduate of the personal financial planning certificate program at UC Irvine. Questions can be sent to her at asklizweston@ hotmail.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012.