In this edition of "Bank of Dad," we answer questions about open enrollment mistakes and how much to put down on your first home.
Open Enrollment is coming up and honestly, I never know if I’m doing it right. What are some of the big mistakes to avoid during the process? What are some things that are important to know. – Jesse A., Lousville
If you’re like a lot of people, you’d rather stick a sharp fork in your eye than sort through the dizzying array of options at open enrollment time. And yet, these are some of the most important financial decisions you’ll make for the upcoming year, so it’s worth giving it some careful attention.
Let’s start with health insurance. One of the biggest snafus you can make is assuming that the plan you used last time is still the best choice, without looking at the premiums, deductibles, and coverage limits. Often, the result of being passive is a top-tier plan that isn’t always worth the higher premiums they charge.
You may find that a high-deductible health plan, or HDHP, is a better deal. These plans are usually qualify you to use a health savings account, which lets you use pre-tax money for your medical costs not covered by insurance. Though it seemingly defies logic, many HDHPs are actually less risky because they have lower caps on out-of-pocket expenses. So it pays to sort through your options.
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Another costly mistake workers make during open enrollment is passing up on Flex Spending Account contributions. As of this year, parents can set aside up to $5,000 for child care expenses (if they file a joint return) and another $2,650 for healthcare costs – all tax-free. The healthcare portion can be used for co-pays, deductibles and a variety of other medical expenses. If you know you’re going to pay for these things anyway, it makes sense to keep that money away from the IRS.
Open enrollment is also a great opportunity to review your life and disability coverage. Often, your employer will provide some benefit to you – in the case of life insurance, it’s usually a year or two worth of salary. But for a lot of families, that just isn’t enough.
However, your company may allow you to buy more coverage through a payroll deduction. Sometimes this is a good deal, especially where disability insurance is concerned (life insurance is often cheaper on the individual market). You’ll want to get quotes from outside providers to see what’s best in your case.
Finally, don’t forget to look over your 401(k) contributions for next year. If you start in your 20s, the general yardstick is to invest 10 to 15 percent of your paycheck in tax-advantaged accounts. If you’ve fallen behind, this might be the time to boost your contribution level. Otherwise, you could find yourself working at an age when you thought you’d enjoying a nice, relaxing retirement.
I know things vary. But how much do you really need to put down on a first-time home? — Kevin M, Chicago
The short answer: less than you might think. While it’s perceived wisdom that you need to lay down 20 percent in order to get a mortgage, that’s hardly the case.
Among the more popular low-down payment options is an FHA home loan, which lets you put as little as 3.5 percent down. One of the great things about this program is that you can qualify even if you have low or middling credit scores.
The financing comes from a private lender, as it would with a typical mortgage. But you pay mortgage insurance each month to a government agency, which protects borrowers against a default. There’s also an upfront premium, which at present equals 1.75 percent of the loan amount.
One of the knocks on FHA mortgages is that the monthly premium doesn’t go away, even when your equity reaches 20 percent of the home’s value (though it’s canceled after 11 years if you put down at least 10 percent when you buy). You may need to refinance in order to get rid of it, and no one knows if interest rates will still be this low when you get to that point.
That’s one of the reasons some borrowers choose to get a conventional loan and pay private mortgage insurance, or PMI, instead. The concept is the same as FHA insurance, but this time your premiums go to a private company that covers your lender’s back side if you’re unable to pay them back.
As long as you pay PMI each month, you can get a conventional loan with as little as three percent down (lenders refer to these as “Conventional 97” loans). They’re a little harder to qualify for – your credit score needs to be at least 620, though it’s higher with some lenders. But the upside is that you can nix the mortgage insurance once your equity hits 20 percent. If you plan to be in your home for five years or more, that can make a huge difference.
Even better are the zero-down programs, though fewer homebuyers qualify. Service members and veterans, for example, may be eligible to get one through the VA. Most borrowers will pay a “funding fee” equal to 2.15 percent – an amount that can be bundled into the loan – but they don’t have to pay monthly mortgage insurance. It’s a pretty great deal for those who have worn a uniform at some point.
Another great option is the USDA Rural Development program, which also provides up to 100 percent of the financing for home purchases. Don’t let the name fool you – you don’t need to buy a farm to qualify. Yes, the program is limited to certain areas, but 97 percent of the land in the U.S. is covered by the program – and that includes a lot of the farther-reaching suburbs. If you live in one of those zones, and your income doesn’t exceed 115 percent of the median wages in your area, it’s something you’ll want to check out.
So take heart if you don’t exactly have a huge bundle of cash to drop on your first home. Talk to multiple lenders and have them give you some numbers regarding the upfront and ongoing costs of these low-down payment programs.
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