Home buying is one of the cornerstones of building wealth. But to ensure that it is truly a wealth-building tool and not a financial burden, you must be prepared for the financial obligations of your investment.
This not only means being able to afford your mortgage and other expenses of owning a home. Instead, it begins as early as being able to save for a down payment.
Purchasing a home is a big financial step and the amount that you need to save for a down payment can seem daunting. Nonetheless, it’s not impossible. Let’s explore how to save for a down payment on a house!
7 Steps to saving for a down payment on a house
1. Determine how much you need to save for your house down payment
The first step in saving for the down payment on your home is knowing exactly how much you need to save. Your down payment amount will always be calculated as a percentage of the home price and depends on your lender and the type of home loan you’ll be leveraging.
Special program loans such as FHA loans for rural residents, VA loans for veterans, and first-time buyer programs may require low- to no- down payment. However, at a minimum for conventional loans, you should expect to save at least 5% of the home price.
Question: What about buying a house with no down payment?
It is ideal to put a 20% down payment on your home to avoid having to pay private mortgage insurance or PMI. Loaning 80% of a home’s price is a huge risk for lenders. So to ensure that they are covered in case you default, PMI is applied to your mortgage payment and will ultimately increase what you pay on your home.
Since you’ll need to start saving for your down payment well before you begin house shopping, you can estimate the amount you need by using your overall home budget or pre-approval amount instead of an actual home price. For instance, if your home budget or pre-approval amount is $150,00 you should plan to save between $7,500 - $30,000 or 5%-20%. Try out this mortgage/house down payment calculator.
You also want to make sure that based on what you are pre-approved for, you can comfortably afford your monthly mortgage payments. The last thing you want is to wind up house poor.
2. Create a monthly savings goal towards your house down payment
Since most people don’t have an extra $30,000 laying around, it’s important to save up for your down payment over time. To do this, you need to create a monthly savings goal. Your savings goal is the amount of money that you can realistically put into savings each month to go toward your down payment.
In order to know exactly how much you can actually save each month, you need to create a budget. Your budget will help you identify how much extra cash flow you have at the end of each month and where you can reduce expenses to increase that amount.
Based on your current income and expenses, determine how much extra money you can put aside each month toward your down payment. This is your monthly savings goal.
3. Add saving for your house down payment to your budget
Once you’ve identified your monthly savings goal, you need to add it to your budget. This means you will begin treating it as an expense—making sure that it gets paid every month. Simply add it as another line item in your current budget and allocate funds toward it each month.
4. Determine your timeframe to purchase your first home
Timing is everything in the housing market. So, the more aggressive that you can get with reducing your expenses and increasing your income, the less time it will take to save for the down payment on your home. To estimate how much time it will take to save, simply divide your down payment target by your monthly savings goal.
If you want to shorten the time that it’ll take to save, simply find creative ways to further reduce your expenses and increase your income to add extra cash toward your savings. Here are a few things that you can try:
- Pick up a side hustle or second job
- Cut expenses like cable, dining out, and shopping
- Pay off debt
- Host a yard sale or sell unused items online
If you find ways to consistently increase your cash flow, simply update your monthly savings goal and budget to reflect that new number.
5. Open a separate savings account to save your house down payment
Once you have your monthly savings goal and have created a line item in your budget, it’s time to start stashing your cash!
Since you’ll be saving a large sum of money, it’s ideal to save it in a place that will work to your advantage. You want to save your money in an account that will allow you to reach your goal faster by providing interest on your money.
Traditional savings or checking accounts don’t provide much interest, so they aren’t ideal for holding your funds. The best options that allow your money to work for you—while being easily accessible—is either a high-yield online savings account or a money market account.
In recent years, online banks have completely changed the landscape of banking. With their high-interest rates and low minimum balances & fees, online savings accounts are a great option for your down payment funds. Likewise, money market accounts provide high-interest rates and accessibility; however, the minimum balance required to open an account can be relatively high.
Decide which option is right for you and open an account specifically for your down payment. You can even go as far as renaming the account, “House Down Payment,” for a little bit of motivation!
6. Automate your savings
To help ensure that you don’t lapse on your savings, automate your monthly transfers to your savings account. Saving money doesn’t come naturally to most people, so use automation to ensure that you are making progress toward your goal and sticking to your plan.
You can do this by having your employer deposit a percentage of your paycheck to your savings account or having your bank automatically transfer funds from your checking account on a specific day of the month. The less that you have to think about doing it, the easier saving for your down payment becomes.
7. Save some more
It’s important to note that your down payment isn’t the only funds that you’ll have to bring to the table when purchasing a home. So while you’re saving for your down payment, be aware that you may also need to save for things like:
- Closing costs
- Inspections & appraisals
- Moving costs
- Furnishing, decor, and/or renovation costs
- Homeowners’ Association fees
Though all of these may not apply to your situation, it’s good to have extra funds on hand for miscellaneous expenses that may come up. You may consider reducing the amount that you put toward your down payment so that you can use the rest of the money to cover these, and other, expenses.
The great news is that the money that you save for the down payment of your home will be put toward your mortgage. That means that the more that you save, the less your monthly mortgage payment will be. Consider this when you are establishing your savings goal.
Be consistent and stick to your plan. Before you know it, you’ll be financially prepared to purchase your home!