Save a down payment before trying to buy a home

Dear Liz: My wife and I are considering buying a home for the first time. We’re planning to switch our accounts from our bank to a credit union. We’re in the midst of receiving a bad report from the bank, and that’s why we want to change. But is that a wise choice when we want to buy a home? Also, what options do we have for a mortgage when we don’t have any money for a down payment? Are we locked into an FHA loan, or are there other choices? We are middle-class people making an average of $40,000 a year with no kids and OK credit scores.

Answer: If you don’t have a down payment saved, you aren’t ready to be homeowners.

Homeownership is expensive, with lots of unexpected costs constantly popping up. Some are relatively minor, like having to replace a worn-out appliance, while others are major, such as having to replace a furnace or a roof.

That’s why homeownership isn’t a good idea for people who aren’t already in the habit of living below their means and saving a decent proportion of their incomes.

Take the next year or so to tweak your spending and save up a down payment. You’ll need at least a 3.5% down payment to qualify for an FHA loan. A bigger down payment will give you more loan options and won’t leave you upside down on your home from the first day. A 20% down payment is often best, since you can avoid private mortgage insurance.

A year also will give you time to polish those credit scores from “OK” to “good.” The higher your scores, the better the interest rate you’ll receive.

But the fact that you’re receiving a “bad report” from your bank is worrisome. You don’t specify what happened, but anything that could be reported to the credit bureaus, such as a missed credit card payment, could cause major damage to your scores. Simply switching to another institution won’t prevent that. And if you’ve piled up a bunch of bounced checks, your credit reports may not be damaged but you could find it difficult to open new accounts at other financial institutions.

Whatever happened, you should try to straighten it out with the bank before you decamp, even if you ultimately decide to switch accounts.

Using a 529 plan to save for college isn’t always best

Dear Liz: I am returning to college in my later years for a second degree. Can I save in a 529 plan for my own college use in two years?

Answer: You can, but why would you want to?

The big benefit to a 529 plan is that your returns can grow tax-free. That’s a boon for parents in higher tax brackets contributing for young children, since their money has years to grow and they can put at least some of their cash into riskier assets, such as stocks.

If you need the money within two years, though, it should be in a cash account that won’t earn much. (The average money market fund pays around 0.02% right now.) You wouldn’t be getting any real growth, so the tax benefit of a 529 plan is minuscule. What you would get are restrictions on how you use the money and possible complications for your tax returns. If you want to use education tax credits, for example, you won’t be able to apply those on expenses you’ve paid with a 529 withdrawal.

A simple FDIC-insured savings account — perhaps at an online bank that pays around 1% — is probably the better way to go. If you want to maximize your chances for financial aid, you might consider saving the money in a Roth IRA, since retirement accounts typically aren’t included in financial aid formulas. You’ll have to pay penalties on the small amount of interest you’ll earn, but your contributions can be withdrawn tax free.

‘Free credit scores’ aren’t free

Dear Liz: Why are companies allowed to advertised “free credit scores” when they’re not really free? They want you to give them a credit card number, then charge you a dollar, and if you don’t call them within seven days to cancel they will charge you $14.95 a month for a credit monitoring service. That’s not free.

Answer: No, it’s not, but these companies profit from people’s confusion about scores.

Many people think we have a right to a free credit score, but we don’t. What we have is a federally mandated right to see our credit reports, which are different from our credit scores. Reports list your credit accounts, whether you’ve paid on time and whether you have negative public records, such as a bankruptcy or foreclosure. Credit scores are three-digit numbers compiled from those reports, but your scores aren’t a part of your reports. The only place to get your free credit reports is https://www.annualcreditreport.com.

If you’re being offered a free score, it’s almost certainly got strings attached like the ones you described, or the score isn’t the FICO score commonly used by lenders.

Liz Weston is the author of “The 10 Commandments of Money: Survive and Thrive in the New Economy.” Questions for possible inclusion in her column may be sent to 3940 Laurel Canyon, No. 238, Studio City, CA 91604 or via https://www.asklizweston.com. Distributed by No More Red Inc.