How to Save For a Down Payment

Save for a House (And More)

Money to Get In
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A down payment is one of the most important pieces of your home purchase: it will affect what you can buy and how much you pay. So how do you save for a down payment successfully – especially if your budget is already stretched thin? Make a plan, and then make it easy to follow through.

Why Make a Down Payment?

Some lenders let you borrow close to 100% of your home’s value. Even government sponsored loans like FHA loans and first-time homebuyer programs allow you to bring just a few percent to the table.

Is that a good idea?

There are several reasons to make a larger down payment – even if you don’t have to.

Interest costs: the more you borrow, the more interest you’ll pay. Especially with large, long-term loans like home loans, the difference in cost is significant. If you minimize your loan balance, your net worth will be better off.

Lower monthly payments: a bigger loan also results in a larger monthly payment. If you think it’s hard to pay the bills or save for a down payment now, how hard will it be if you’re hit with increased medical costs or reduced pay? Keeping your payments low is something that you’ll appreciate later in life. If it turns out that you always have more than enough money each month, you can put the extra money towards other goals like retirement.

Dodge additional fees: lenders might allow you to make a small down payment, but you’ll pay for that privilege. If you put down less than 20%, expect to pay private mortgage insurance (PMI), which means paying additional charges (whether it’s a separate fee each month or part of a higher interest rate that raises your monthly payment).

Eventually, you might be able to cancel PMI if you build equity in your home, but that process is often slower than you’d like. What’s more, lenders charge higher interest rates on riskier loans. A higher loan to value ratio means they’re taking more risk – they don’t have as much cushion to get their money back if they have to foreclose.

Stay above water: sometimes things change. If your home loses value and you want to sell, it’s a lot harder when you’re underwater (when you owe more than your home is worth) – and that’s more likely when you skimp on the down payment. You might need to bring cash to the table just to get out.

How to Save for a Down Payment

Planning is the first step. Set goals and get everybody on the same page. Discuss your expectations relating to:

  • How much you want to (and can) save each month
  • How much you want to spend on a home (purchase price and monthly payments)
  • How soon you want to buy
  • How willing you are to compromise (a less expensive house, sacrifices to save more, and so on)

With your goals in mind, “back in” to arrive at more specific numbers. For example, there’s no sense in planning to buy a $5 million house if you can’t afford the payments. One way to figure out how much you can afford is to use the debt to income ratio, which gives you a maximum amount that lenders will approve you for – but it’s rarely wise to borrow the maximum.

For a simplified example, you might assume that 28% is the maximum you should spend on housing payments (also known as the front-end ratio). If you earn $3,000 per month, 28% of that is $840, so you could expect so spend up to $840 on principal, interest, taxes, and insurance (PITI).

Different lenders have different (sometimes higher) thresholds – ask your mortgage broker or lender.

With this information, you have an idea of what size loan you might be approved for. At 5% interest, a $150,000 30-year fixed rate loan has a payment of $805.23, so you might plan on borrowing roughly that much. Now you have more information: if you can borrow $150,000, and that amount should be no more than 80% of the home’s value, then you might shop for homes valued around $187,500 (using our sample income above). Divide $150,000 by 80% to arrive at that number.

Finally, if you know that you’re shopping for homes around $187,000 and you want to save a 20% down payment, you’ll need to come up with $37,500 ($150,000 borrowed plus $37,500 down equals $187,500 total).

Need a little help with those calculations?

Create a Separate Place

Once you’re ready to start saving, create a special place for your down payment savings. You don’t want that money in your normal checking or savings account, mingling with your pay and monthly expenses: you might be tempted to spend it, or you might forget how much you’ve saved for your down payment. It’s also nice (and motivating) to watch your progress, which you can’t do if money keeps moving in and out.

Online bank accounts are a great place for down payments: they often have no minimum balance requirements or monthly fees, and they pay a decent return. But be aware that your deposits – the money you add to the account – will be the driving factor in reaching your goal; the interest rate, especially over a few short years, will not make a huge difference (although every little bit helps). It’s hard to earn your way into a large down payment – you really need to build it using your own savings.

If you already have an online bank account, see if it’s possible to create a separate subaccount. This won’t require you to open a new account, and you can often nickname these accounts to keep your goals straight. Your brick-and-mortar bank might allow you to open a new savings account as well.

If you plan to save for more than a year or two, consider using certificates of deposit (CDs) as well as money market accounts to try and increase your earnings.

Automate the Process

Saving will only happen if it’s easy, and the easiest way to build up your down payment fund is to set up automatic electronic contributions to that fund. Most bank accounts will allow you to shift money into your dedicated savings account every month (or however often you prefer), even if it’s at a different bank. Set up a recurring transfer so that you never forget.

Your employer might also be able to help. Ask if a portion of your pay can be direct-deposited to your down payment account – that way it’ll never be in your “normal” checking account long enough to tempt you.

If you use a budget and track your expenses, make this part of your budget.

Save While Paying off Debt?

If you’re paying down debt, saving for a down payment is especially hard. Whether or not it’s a good idea probably depends on the type of debt you have.

Toxic debt: if you have high-interest rate debt (like credit card debt), it’s probably best to put your money towards eliminating the debt – not saving for a down payment. You’re paying a lot in interest, and that will only make it harder to reach all of your financial goals (including buying a house). What’s more, you’re not in a strong financial position right now, and when you buy a home you’ll almost certainly want to spend money on furniture and improvements – not to mention the occasional nasty surprise. Finally, your required payments on the credit cards will affect your debt to income ratios (and possibly your credit scores). If you can borrow at low promotional rates using balance transfer offers it might make sense to save and pay off debt, but if that debt becomes toxic again, you might want to reevaluate and use your savings for paying off the debt.

Student loans: things get more complicated if you have student debt. Those loans might be around for years or decades, and they (unlike credit card debt) don’t necessarily signal that you’re on shaky financial ground. Whether or not to save for a down payment might depend on:

  • Your housing and rental costs (if you can actually spend less by buying in your market)
  • Your degree and career (if you can realistically expect increased earnings – or loan forgiveness for nonprofit workers)
  • Your interest rates (depending on when you graduated or consolidated, you might have locked in at low rates)

In some cases, it makes perfectly good sense to get a small condo or starter home – assuming it otherwise makes sense to buy – while paying off student loans. Just be sure you can live with the place for many years to come. If you’re tempted to upsize before your debts are paid off, it’s risky to stretch things as much as you can, and you might find yourself with a “house poor” lifestyle.

Be flexible: no matter what kind of debt you have, you can always save for a year or so and evaluate how things are going. If you made the wrong choice, you can always put that saved money towards your loan in a large lump-sum. That means delaying your home purchase – but you’ll also be in a better position to start strong.

How to Save for a Down Payment – Fast

Saving a lot of money takes time. But you might not have time – maybe there’s a child on the way and you need more space, or you need to get out of a bad situation.

You’ve got to realize that it’s simply not easy to build up a large down payment quickly. If you’re fortunate enough to have a high income, you might be able to just quit spending, but most people are not in that situation. Building up a large chunk of change will require drastic measures, including basic cost-cutting like giving up cable and eating out.

  • Sell your stuff: if you really want to build up your assets, you might need to part with some of the things you love (or things that have just been sitting around)
  • Take on extra work: it’s never fun to go back to work (after you just got off work) but more income makes it easier to save
  • Shared housing: if you’re not already living with roommates (whether it’s your place or theirs), there might be an opportunity to save or earn a little extra
  • Ask for help: if you’ve got friends and family who are willing and able to help, you might be able to raise a few bucks that way (some have even turned to crowdsourcing for a down payment)

Now that you’re on your way to home ownership, practice the art of paying yourself first – which is essential both before and after you buy a house.