When you’re buying a house, part of the money will come from you and the rest will come from the bank. The part that you’ll come up with is called the down payment, and the bigger it is, the less you’ll have to borrow.
The biggest obstacle for first-time homebuyers is saving for a down payment. Making smaller, more actionable changes to your finances might make the process less daunting. Although it will take some time to save up a down payment, there are a few shortcuts and pointers that can help you get there sooner than you thought. Check out these five tips.
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1. Determine how much to save for a down payment
As a percentage of the home price, the down payment is the upfront cash you pay when you get a home loan. There’s a common misconception that you have to put down 20% to get a mortgage. You will be able to avoid paying for private mortgage insurance by putting 20% down, but lenders rarely ask for such a big down payment. Learn more about how much mortgage you can afford.
When you have a good credit score and manageable debts, you may well be able to borrow more and put down less. There are also different down payment requirements for different kinds of home loans.
- Conventional loans. A conventional mortgage adheres to Freddie Mac and Fannie Mae’s conforming loan standards. Conforming loan standards make conventional mortgages more difficult to qualify for. You can, however, make a down payment as low as 3% if you have solid financials.
- FHA loans. The Federal Housing Administration backs FHA loans, which require as little as 3.5% down. However, down payment amounts vary depending on credit scores.
- VA loans. VA loans, backed by the US Department of Veterans Affairs, waive the down payment requirement. Service members and their spouses qualify for VA loans if they are current or former U.S. service members.
- USDA loans. A down payment is usually not required on USDA loans, which are backed by the US Department of Agriculture. The loans are intended for borrowers in rural and suburban areas, and income limits may apply.
- Jumbo loans. Jumbo loans are mortgages that exceed conforming loan limits. This type of mortgage cannot be insured or backed like other types of loans, so lenders usually require a higher down payment.
You’ll also want to account for other costs of owning a home when deciding how much to save for a down payment. In addition to closing costs (usually 2%-5% of the purchase price), moving expenses, and an emergency fund for repairs, these costs can add up. Learn more about the complete costs of buying a home.
2. Save more money by using money tips
It can help mount a multifaceted attack, irrespective of the dollar amount. Here are a few money moves you can make to put down a down payment faster:
- Save extra money. Add to your down payment savings if you receive a raise, bonus, or simply a tax refund. You might be motivated to grow your savings balance even further if you receive a windfall.
- Automate saving. Automate the transfer of funds from your checking account to your savings account. That makes the process easier – and maybe a little less painful. You may also be able to have some of your paycheck deposited directly into a savings account by your employer.
- Use a cash-back credit card. Put that money back toward your down payment fund. If you want to maximize your cash back, put as many purchases on your cash-back credit card as possible, making sure to pay it off each month so that interest charges do not deplete your earnings.
- Stash spare change. Don’t put it in a piggy bank (but you can if you want). Many banks and saving apps offer users the option of rounding up purchases to the nearest dollar and saving the change.
- Drive smarter. Did you pay off your car? Save the monthly payment by restraining yourself from buying a new vehicle. Are you still paying for your wheels? If so, consider refinancing the loan. Compare car insurance rates if you haven’t changed them in a while (and put the savings towards your savings).
3. Ensure that your down payment savings are in the right account
You’re saving as much as possible towards your down payment, but you don’t want to leave it in your checking account. Where should it go?
You might first think about investing it in the hope of boosting your return. However, unless you’re planning on buying a home in the near future – say, eight to 10 years or more – do not do it. Short-term investments are too volatile. It doesn’t take much for a severe market downturn to set your efforts back significantly, and discourage them as well.
Here are some, possibly better, options:
The easiest and simplest way to store your funds is probably in a savings account with the same bank or credit union where you do your checking. You can easily transfer money from your checking account to an existing savings account once you’ve opened it, either manually or on a recurring basis.
Since the funds are guaranteed by the National Credit Union Association (NCUA) or the Federal Deposit Insurance Corporation (FDIC), they are safe. But there are downsides as well. Savings accounts typically come with very low interest rates, so you get very little return on your funds.
High-Yield Savings Account
Choose a high-yield savings account if you want to earn more interest while still being protected by the FDIC or NCUA. Once again, your current bank is the simplest option. Actually, some banks only allow existing customers to open these accounts.
Unlike regular savings accounts, high-yield savings accounts pay a higher interest rate, sometimes as much as 10 to 20 times what regular savings accounts pay. The best rates are offered by online-only banks, however. You may find that one of these virtual institutions is the best option for saving if you don’t mind the lack of brick-and-mortar locations.
First-Time Homebuyers Savings Account
To encourage first-time homebuyers and assist potential buyers, several states offer special rates and conditions. Before you open an account, make sure to check the program’s perks.
As of March 2022, these accounts will be offered in Alabama, Colorado, Iowa, Idaho, Michigan, Minnesota, Mississippi, Montana, Oregon, and Virginia. Other states may also allow them. Massachusetts, Maryland, and Kansas are considering this.
Consider accumulating your down payment fund in an investment account at a major brokerage firm if you’re willing to take higher risks. With this account, you can invest your money in stocks and mutual funds, which could earn you higher returns than even high-yield savings accounts.
4. Resist dipping into your other savings
You might be tempted – after all, the money is right there – but don’t deplete existing savings. These include:
- Your emergency fund. If you set money aside for an emergency, you should wait until you need it, such as when you’re buying a house. Soon after moving day, you might have to cover an appraisal gap or pay for an expensive repair.
- Your 401(k). The risk of taking a loan from a 401(k) is high. If you lose your job, you must repay the loan by the next tax filing deadline, or it will be taxed as ordinary income, plus a 10% penalty if taken before age 5912. 401(k) early withdrawals may be allowed under a hardship withdrawal exemption (buying a house counts as an “immediate and heavy financial need,” per the IRS), but depleting your retirement savings now can have serious implications later on.
- Your individual retirement account. Purchase of a home with an IRA can be made without penalties for first-time home buyers. However, if it’s a Roth IRA, you’ll have to pay the taxes due on the withdrawal. Using retirement savings for home purchases may seem like a good idea, but it can set back your retirement plans, and few people can afford to fall behind on saving for retirement.
5. Ask for help in saving for a down payment
Different types of down payment assistance can help you regardless of where you are in your savings journey.
First-time home buyer programs are available locally and at the state level. In addition to down payment grants, these programs often provide tax credits and closing cost assistance. Most often, housing finance agencies or the Department of Housing and Urban Development administer them. The requirements for each program can vary, though – some may require you to complete a home buyer education course, for example.
Gift money from relatives and friends can boost your confidence if you’re lucky enough to receive it. You usually need to document how you received the money – it cannot be a loan. Every loan program has its own rules for using gift money. A minimum amount of your own funds may be required in some cases in addition to gift money.