Even if you know how much house you can afford, you still have to figure out the best way to save for it.
Some homebuyers forget this step. That’s why the average down payment on a new mortgage in 2016 was just 11 percent of the purchase price, according to a National Association of Realtors survey.
Here’s how to ensure you can make a larger down payment, and clear the 20 percent threshold to avoid private mortgage insurance (PMI).
How to save for a down payment
Just because some lenders let you sign a mortgage agreement with 5 to 10 percent down doesn’t mean you should. The higher a down payment you can make, the less interest you’ll pay over time. Our home mortgage calculator makes this pretty clear.
But figuring out how to save for a down payment on a house is the tricky part.
Most aspiring homebuyers take their spare change at the end of each month and put that toward their big savings goal. But if the goal of buying a home is an important one, prioritize it by including it in your current budget.
Your down payment should be a line item. It might sit right alongside essentials like rent, groceries, and debt payments.
To figure out your savings target, start with four weeks of after-tax income, said G. Brian Davis, director of education at Spark Rental.
“Not their annual income divided by 12, but four weeks’ pay, since that’s what they actually have to work with in most months,” Davis said. “Of that after-tax pay, they should set a target savings rate, preferably between 10 and 20 percent.”
That money should be moved, one automatic transfer at a time, from your checking account to an account set up purely for your down payment on a house.
4 ways to save for a down payment on a house
Poll a group of financial planners and real estate agents, and you might start hearing the same advice over and over again. That’s because there are some widely held truths about saving for a down payment. Here are the most common:
- Prioritize a lower-risk account that ensures slow, steady growth. It’d be wise to avoid accounts that put your savings at risk in the short term.
- Set up a new account for the sole purpose of saving for a home. It’ll be easier to budget and track your progress this way.
- Automate contributions to your account. This can keep you in the habit of saving and help you go without those extra dollars each month.
You can also research the varying interest rates on different savings account types to determine the best spot to keep your down payment. If you plan to pull money out of your 401(k) for your down payment, you’ll want to research the potential drawbacks.
But the general do’s and don’ts might not be what works best for you. For example, the best savings vehicle for you might not be best for someone else.
If you’re hoping to purchase a home within five years, here are four account types recommended by financial planners.
1. Traditional or Roth IRAs
A traditional IRA might be the top option for first-time homebuyers. The IRS allows each member of a married couple to take out as much as $10,000 for a home without having to pay the 10 percent penalty for an early withdrawal. They would just have to pay the taxes on their combined, maximum withdrawal of $20,000.
The same goes for a Roth IRA, although the tax hit would be smaller, as contributions are made with after-tax income.
“Since a [Federal Housing Administration] loan only requires you put down 3.5 percent of the value of the home for down payment, the $20,000 should more than cover it,” said Ben Barzideh, a wealth advisor at Piershale Financial Group. “I’ve had younger clients who have done that.”
2. Municipal bonds
“How far out the goal is for a down payment on a home will determine how aggressive or conservative you should be with the funds,” said Tyler Huck, vice president of oXYGen Financial.
If your goal is to buy a home within five years, Huck said you should take the conservative approach by investing in your state’s municipal bond funds. All interest and dividends paid off in these types of investments are tax-free, he added.
3. Money markets and CDs
Shop around for the best possible interest rate on a money market account or a certificate of deposit (CD). Compared to a traditional savings account, these types of accounts typically offer better rates.
However, a CD will limit access to your savings for a fixed period. Money market accounts, meanwhile, might come with higher minimum balance requirements.
You might be tempted to grow your money faster elsewhere. “But one down year during the saving period could undo months of saving,” said Ilene Davis, a certified financial planner.
4. Savings account
A basic savings account is the safest way to store your future down payment. It also keeps your money accessible in the event your dream home comes onto the market in your price range.
You might consider opening your new account at an online bank, which usually beats the rates of national brick-and-mortar banks. These days, you might be able to score a 1 percent return on your money.
“You don’t want to put the money that you are saving for short-term goals in riskier assets such as stocks in bonds,” said Drew Feutz, a certified financial planner at Market Street Wealth Management Advisors. “These assets should be used for more intermediate and long-term goals.”
How saving for a down payment is unique
Aside from how long it takes to save for a home, saving for one is unlike the other big goals you might track in the money-management app Mint. That’s because the down payment is only a starting point.
If you’re unable to make a down payment that is at least 20 percent of the sale price, for example, you’ll also have to budget for PMI.
Tack that onto your monthly mortgage payments and other home-related fees:
- Escrow costs
- Home insurance
- Maintenance costs
- Property taxes
- Homeowners association or co-op fees
Each of these costs could be planned for in your savings target. The more time you can give yourself to plan, the better off you’ll be.
You shouldn’t feel any rush to save your down payment, either. Nearly two-thirds of respondents to a 2017 Apartment List survey, for example, will need more than five years to save a 10 percent down payment.
Make sure to include other expenses of buying a home when you budget for your down payment. You might decide to decrease your down payment to keep more cash on hand for an emergency home repair.
Knowing how to save for a down payment — and what kind of account to do it in — are just the first steps of the home-buying process. Familiarizing yourself with the rest might seem like a tall order, which is why you’ll almost always want to hire a real estate professional.
If you’re not that far along yet, it might be worth reviewing the boxes you should check before buying a home.
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1 Important Disclosures for Earnest.
To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest fixed rate loan rates range from 2.98% APR (with Auto Pay) to 5.79% APR (with Auto Pay). Variable rate loan rates range from 1.99% APR (with Auto Pay) to 5.64% APR (with Auto Pay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms 10 years or less. For loan terms of 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 1.82% and 5.50% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of July 31, 2020, and are subject to change based on market conditions and borrower eligibility.
Auto Pay discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
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2 Important Disclosures for Laurel Road.
Laurel Road Disclosures
All credit products are subject to credit approval.
Laurel Road began originating student loans in 2013 and has since helped thousands of professionals with undergraduate and postgraduate degrees consolidate and refinance more than $4 billion in federal and private school loans. Laurel Road also offers a suite of online graduate school loan products and personal loans that help simplify lending through customized technology and personalized service. In April 2019, Laurel Road was acquired by KeyBank, one of the nation’s largest bank-based financial services companies. Laurel Road is a brand of KeyBank National Association offering online lending products in all 50 U.S. states, Washington, D.C., and Puerto Rico. All loans are provided by KeyBank National Association, a nationally chartered bank. Member FDIC. For more information, visit www.laurelroad.com.
As used throughout these Terms & Conditions, the term “Lender” refers to KeyBank National Association and its affiliates, agents, guaranty insurers, investors, assigns, and successors in interest.
Assumptions: Repayment examples above assume a loan amount of $10,000 with repayment beginning immediately following disbursement. Repayment examples do not include the 0.25% AutoPay Discount.
Annual Percentage Rate (“APR”): This term represents the actual cost of financing to the borrower over the life of the loan expressed as a yearly rate.
Interest Rate: A simple annual rate that is applied to an unpaid balance.
Variable Rates: The current index for variable rate loans is derived from the one-month London Interbank Offered Rate (“LIBOR”) and changes in the LIBOR index may cause your monthly payment to increase. Borrowers who take out a term of 5, 7, or 10 years will have a maximum interest rate of 9%, those who take out a 15 or 20-year variable loan will have a maximum interest rate of 10%.
KEYBANK NATIONAL ASSOCIATION RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE.
This information is current as of September 9, 2020. Information and rates are subject to change without notice.
3 Important Disclosures for SoFi.
4 Important Disclosures for Splash Financial.
Splash Financial Disclosures
Terms and Conditions apply. Splash reserves the right to modify or discontinue products and benefits at any time without notice. Rates and terms are also subject to change at any time without notice. Offers are subject to credit approval. To qualify, a borrower must be a U.S. citizen or permanent resident in an eligible state and meet applicable underwriting requirements. Not all borrowers receive the lowest rate. Lowest rates are reserved for the highest qualified borrowers. If approved, your actual rate will be within a range of rates and will depend on a variety of factors, including term of loan, a responsible financial history, income and other factors. Refinancing or consolidating private and federal student loans may not be the right decision for everyone. Federal loans carry special benefits not available for loans made through Splash Financial, for example, public service loan forgiveness and economic hardship programs, fee waivers and rebates on the principal, which may not be accessible to you after you refinance. The rates displayed may include a 0.25% autopay discount.
The information you provide to us is an inquiry to determine whether we or our lenders can make a loan offer that meets your needs. If we or any of our lending partners has an available loan offer for you, you will be invited to submit a loan application to the lender for its review. We do not guarantee that you will receive any loan offers or that your loan application will be approved. Offers are subject to credit approval and are available only to U.S. citizens or permanent residents who meet applicable underwriting requirements. Not all borrowers will receive the lowest rates, which are available to the most qualified borrowers. Participating lenders, rates and terms are subject to change at any time without notice.
To check the rates and terms you qualify for, Splash Financial conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, the lender will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.
Splash Financial and our lending partners reserve the right to modify or discontinue products and benefits at any time without notice. To qualify, a borrower must be a U.S. citizen and meet our lending partner’s underwriting requirements. Lowest rates are reserved for the highest qualified borrowers. This information is current as of September 10, 2020.
5 Important Disclosures for CommonBond.
Offered terms are subject to change and state law restriction. Loans are offered by CommonBond Lending, LLC (NMLS # 1175900), NMLS Consumer Access. If you are approved for a loan, the interest rate offered will depend on your credit profile, your application, the loan term selected and will be within the ranges of rates shown. All Annual Percentage Rates (APRs) displayed assume borrowers enroll in auto pay and account for the 0.25% reduction in interest rate. All variable rates are based on a 1-month LIBOR assumption of 0.16% effective August 10, 2020.