Offering a down payment on a home can save you a lot of money in the long run. Even if you don’t plan on buying a home for several years, you might be thinking about starting to save for a down payment.
In these five steps, we’ll cover how to save for a down payment on a house and some of the options you have in regards to financing and loans.
How Much Should You Really Save?
Before we get into how to save for a down payment, we first want to cover how much money you should really be saving. You’ll find in your research that 20% is a common answer. It is a safe number, especially because it helps avoid additional costs like private mortgage insurance (PMI). But, if you’re not concerned about PMI, there isn’t a rule that says you have to put down 20%.
At a minimum, a conventional mortgage usually requires a down payment of at least 5% of the purchase price while an FHA loan requires a minimum of 3.5% of the purchase price. Regardless of the minimum percentage allowed, anything under 20% will require PMI which comes out around 0.5% to 1% of the loan amount and is tacked onto your monthly house payment.
While 20% should be the goal, don’t let that keep you from buying a home. Sometimes a smaller down payment can be a smarter option for you financially. Every situation should be weighed on merit and based on your long- and short-term goals. If you’re more comfortable putting forward a lower down payment, you should check out FHA or VA loans, or inquire with your local housing authorities for programs that offer first-time buyers and low- to moderate-income families a lower down payment.
How to Save for a Down Payment
1) Figure Out How Much You'll Need
To start, you’ll want to figure out how much you can comfortably afford to pay each month on a future mortgage, as well as how much you can comfortably set aside every month in a savings account. You can use an online calculator to figure out how much down payment you’ll need based on the various percentages of a down payment, potential PMI costs and how different each scenario would make your monthly payments.
2) Make Room in Your Budget
Since we’re talking about saving thousands of dollars, you might need to clear some room in your budget. That could mean earning additional income, cutting back on expenses, or both. Making room in your budget can help you save the kind of money you’ll need for your down payment, and it will also prepare you for managing the type of tighter budget required for homeownership.
3) Determine Your Timeframe
Based on how much money you can afford to set aside every month, you should be able to calculate how long it will take to save for your down payment. For example, if you can afford a $330,000 home and want to put down 20%, you’ll need to save $66,000. If you realize you can only afford to put away $1,000 in savings per month, it will take you about five-and-a-half years to save. But, if you realize that you only want to put down half that amount, it will take you less than three years to save.
4) Find the Best Way to Save
Since the money you’re saving for your down payment has a specific purpose and you might have a timeframe you want to purchase within, you should not save money in risk-type investment vehicles like stocks. Instead, you should look into high-yield savings or a money market account. This way, you’ll have more interest in these accounts and make your money work for you. You can also put it into a certificate of deposit which may have less flexibility and liquidity, but the principal protection and yields are much better.
5) Set Up an Automated Savings Plan
Unless you’re a saver by nature, you’ll need to automate your savings process to help you. That might mean some sort of payroll savings plan. Just like a 401(k) plan, you should allocate a certain percentage of regular pay to go into a savings account dedicated to your down payment. This removes the temptation and ability to spend the money on other purposes.
Buying a home can seem like a long process, but all these preparations help you plan for homeownership. If you think you may be ready to buy a home or if you have questions about home-buying, contact one of our HomeSmart agents today. When it comes to the real estate market and buying a house, they are the experts. They can help you determine what you’ll get for the mortgage you can afford, when the best time to buy is, and when you should start looking.