You might already be thinking: “Saving up to buy a home is no small feat.”
You’d be correct.
But, start saving today and you’ll be most prepared to pull the trigger when you come across that dream home.
The first step:
Build up the funds for a down payment.
Learn how to save up for a down payment, including how much you should aim to save. And, use the different ways that can make it easier to reach this important financial goal.
The Right Amount for a Down Payment
One of the most common questions asked by prospective homebuyers:
How much should I have for a down payment?
There is no right answer here.
The right amount to save for a down payment depends on your target price range, which may be vastly different from someone else.
Whatever the price range that you’re aiming for, the industry rule is to have a down payment equal to 20 percent of the home price.
This is the amount that lenders will prefer to see before they’re ready to approve your mortgage application.
Note: When you put at least 20 percent down, lenders don’t require you to pay for private mortgage insurance (PMI). This type of insurance protects mortgage companies in case you don’t make your payments to the point where foreclosure is necessary.
Remember, that should be your goal (and it’s even better if you can save up even more for those unexpected costs involved with buying a home).
Here are some examples based on approximate median home prices in certain major U.S. metropolitan areas:
Pittsburgh, PA: $125,000
- 10% down payment: $12,500
- 20% down payment: $25,000
- 30% down payment: $37,500
To accumulate the 20% down payment in 5 years, you’ll need to save roughly $417 per month. If you keep the money in a savings account that earns 2.00% APY, you can reach that goal with $396 per month.
New York, NY: $425,000
- 10% down payment: $42,500
- 20% down payment: $85,000
- 30% down payment: $127,500
To accumulate the 20% down payment in 5 years, you’ll need to save roughly $1,417 per month. If you keep the money in a savings account that earns 2.00% APY, you can reach that goal with $1,346 per month.
San Jose, CA: $1,000,000
- 10% down payment: $100,000
- 20% down payment: $200,000
- 30% down payment: $300,000
To accumulate the 20% down payment in 5 years, you’ll need to save roughly $3,333 per month. If you keep the money in a savings account that earns 2.00% APY, you can reach that goal with $3,176 per month.
Where to Save Your Down Payment
As the road to a down payment can be a very long one, you’ll want a place that’s designated for this purpose.
A savings account is the perfect place because it is easily accessible. This makes it easy to put money when you want (and easy to access when you’re ready to buy).
While you can use a regular savings account from a local bank in your neighborhood, it’s probably not the best option.
Instead, you should go with a savings account from an online bank.
Simply, online savings accounts tend to have no monthly fees and very high interest rates.
First, you don’t want to risk having to pay a fee in order to save money. It’s rather counterintuitive to your goal.
Second, online banks don’t have to pay the expenses of operating branches. This allows the banks to offer savings rates that are hundreds of times as much as the brick-and-mortar banks.
When you’re building up large balances in a savings account, your interest earnings can add up — and reduce the time that it’ll take save up for a down payment.
Put Your Savings on Autopilot
For many people, sticking to a savings plan is tough.
More often than not, the plan gets derailed and the goal of buying a home is never quite within reach.
What you can do:
To remove the need for willpower or discipline to accomplish this savings goal, automate the entire process.
This means moving money into your down payment fund without any work on your part.
There are two main ways that you can put your savings on autopilot:
Partial direct deposit
If you are paid via direct deposit, you’re probably setting 100 percent of those funds to be sent to your checking account.
It makes sense.
A checking account is the hub of your finances. You want to have all your money go through that account.
You need to put in effort to transfer money into your savings. You might get lazy. You might forget.
Some people even feel like they are “losing” money for no reason by transferring the funds out of the checking account.
Ask your employer to split your paycheck so that a partial direct deposit goes directly into your down payment fund. You don’t have to lift a finger or worry about being forgetful. And, you never saw the money enter your account so you won’t “miss” it.
Another way to save effortlessly is to set up recurring transfers that initiate automatically based on rules that you’ve set.
Configure a recurring transfer that kicks in right after you get a direct deposit.
You want those funds to go towards your down payment savings as soon as possible.
That way, you’re not tempted to spend it on things you don’t need.
Tap Your Retirement Account
If you’ve built up savings in a retirement account, you may be able to withdraw some of those funds for the strict purpose of a down payment on your first home purchase.
After you’ve held the Roth IRA for at least five years, you can withdraw up to $10,000 before retirement without paying any income tax or penalty.
With a traditional IRA, the rules are different.
You can also withdraw up to $10,000 before retirement age, but you’ll have to pay income tax on the amount. Still, there’s not penalty because you’re using it for a down payment.
With a 401(k) plan, all withdrawals before retirement will result in taxes and penalties.
There’s the option of a 401(k) loan, but it isn’t advised in most situations.
Again, saving for a down payment is a long-term goal.
Whether you’re thinking about buying a house or not, it’s a big purchase that you should be prepared for.
Because a down payment is not small amount, start saving now.