How to Save for a Down Payment on a House

down payment on a house

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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