The Cash That's Left

(Photo courtesy of Getty Images)

By Elizabeth Razzi
Special to The Washington Post
Saturday, June 6, 2009

It's the rare home buyer who doesn't walk away from the closing table feeling exhilarated but close to broke. Most have scraped together every dollar they could find to make a down payment and cover the closing costs.

But buyers sometimes are surprised to learn that lenders will disapprove of them draining their bank accounts dry. It doesn't matter that they used the cash to make a bigger down payment or to pay off other debts -- steps that usually win an "attaboy" from a loan officer. You still need to have some cash in reserve to cover the unexpected, whether it be a layoff or unpaid furlough, a broken-down car, or a leaky roof.

Judy Redpath, a certified financial planner in Reston, recommends that even first-time buyers maintain at least three months of living expenses, preferably six months. That includes the new mortgage payment and all other bills. She acknowledged that the goal is difficult for first-time buyers.

"They should know they will set money aside every month to build that up," she said. "Let's learn from those people who are losing their houses right now."

Aside from emergency expenses, Redpath pointed to the additional costs of furnishing a home. Buyers often don't anticipate such expenses, and they can lead to big credit card balances.

Buyers of new detached houses spend an average of $4,900 during the year after the purchase, according to a study of federal statistics published in December by the National Association of Home Builders. Buyers of resale homes spend an extra $3,600, on average, during their first year. The money goes to repairs and remodeling (even in new homes), appliances, televisions, mattresses, sofas, window coverings and other furnishings, according to the NAHB.

Most first-time buyers are taking out mortgages insured by the Federal Housing Administration, according to the National Association of Realtors. FHA mortgages require a down payment of at least 3.5 percent and do not require that people buying a single-family primary residence have a certain amount of cash reserves left after closing. But you'll be hard-put to find a financial adviser who says the reserves aren't necessary for a borrower's financial health.

The government's new $8,000 tax credit for first-time home buyers (defined as those who have not owned a home in the past three years) can help borrowers with the cash crunch. The FHA recently announced that private lenders, state housing agencies and some nonprofit groups would be allowed to lend buyers the $8,000 for upfront closing costs or to increase their down payment. (The money cannot substitute for the minimum 3.5 percent down payment.)

Buyers who qualify for the credit also can file an amended return after their sale closes and tap the $8,000 as a refund on their 2008 taxes and use it to replenish their savings. The new tax credit is available only for deals that close by Dec. 1, and the amount is phased out for married couples earning $150,000 or more, or singles earning $75,000 or more.

"This year's a special year because first-time home buyers are going to get a great tax credit," Redpath said. "But they still need to look at their cash flow."

Borrowers who need loans larger than the FHA's limit, $729,750 in the Washington area, can't use the program. And anyone making less than a 20 percent down payment with a non-FHA loan faces lenders' and mortgage insurers' requirements for cash reserves.

Most require at least two months of mortgage payments -- including principal, interest, property taxes and insurance -- remaining after closing. "It might be more than that if some elements of the qualification are compromised," said Angela Karanas, senior vice president for credit risk with PMI Mortgage Insurance.

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