Are you planning to purchase a new home? Perusing the internet for new listings and fantasying about your life in a new house is the exciting part. Setting money aside for a down payment, on the other hand, may give you heart palpitations. It is an essential part of the home-buying process, though. So, to help you get started, here’s how to save for a down payment, including safe, short-term investments to grow your money.
For more help planning your homebuying journey, consider working with a financial advisor.
How Much Do You Need to Save for a Down Payment?
Before you begin stacking your pennies for a down payment, you need to pinpoint the right amount. Without a number in mind, it might be more challenging to plan for the purchase of a home. Typically, if you plan to apply for a conventional loan, you will need to put down at least 20% of the purchase price of the home to qualify. When you’re able to put 20% down on a home, you can usually reduce your interest and avoid paying mortgage insurance, which protects the lender if you default on the loan.
But, for some homebuyers, 20% might be unattainable. In fact, according to October 2021 Realtors® Confidence Index Report, 72% of first-time homebuyers put less than 20% down on their new home purchase. And 50% of total homebuyers put less than 20% down.
So, it’s possible to qualify for a conventional mortgage with as much as 3% down. Other loans such as VA loans, FHA loans and USDA also have low down payment requirements or no down payment requirements at all. VA Loans, for example, don’t have down payment requirements to qualify for a loan. However, you must have at least a 620 credit score.
In addition to pinpointing a down payment amount, you’ll want to calculate how much you can afford to spend on your home. Financial experts recommend spending 30% of your income on housing. This means that one-third of your income should be devoted towards all housing expenses, including your mortgage, taxes, utilities and repairs.
Do your homework to identify what type of loan is right for your situation and how much you feel comfortable spending. Then, understanding the mortgage eligibility requirements can help you decide how much you should put away for your down payment.
How to Save For A Down Payment
After determining a down payment sum, there are several things you can do to help save for the home of your dreams.
Create a Budget
It’s essential to know where your money is spent when you’re saving for a down payment. You may find places to save and costs to cut as you look at your expenses and income. As you see how much you’ve spent on additional items like shopping, entertainment and apparel, you can reduce where needed.
To create a budget, start by adding up all of your monthly expenses. Then, determine how much money you have every month and subtract your expenses. You should get a number over zero, ensuring you’re living within your means.
Once you know how much money is coming in and out, you can select a budgeting method like the 50/30/20 strategy. With this strategy, you aim to spend 50% of your income on your needs, such as housing, 30% on wants, such as clothes and entertainment and 20% on debt and savings.
Manually setting money aside every month is often challenging. But, putting your savings on autopilot eliminates the hassle and ensures you’re consistent with your savings. Most bank accounts let you set up an auto-deposit regularly. You can determine the amounts and the dates to which the amounts deposit into your down payment savings fund.
Keep in mind, most savings accounts have limits on the number of distributions you can take in any given year. Therefore, it might be less tempting to tap into your down payment fund for other expenses.
Boost Your Income
When it comes to saving for your future, boosting your income is always a great solution. Asking for a raise is one way to help you stash away more cash. You could also consider starting a side hustle to participate in the gig economy. From joining a rideshare service to selling your crafts off Etsy, there are thousands of ways you can make extra cash outside of your full-time job.
Cutting costs is one way to save faster for a down payment. While saving for a down payment, reviewing all of your expenses and figuring out what you can cut can help you gather the necessary funds.
Start reviewing your expenses that aren’t essential. How many streaming services do you have — and do you use them all? Start eating at home more or cut out fast food and restaurants altogether for a period of time. Maybe even cancel your gym membership; you can get a good workout for free from videos online or jogging outside.
You can even review necessary expenses such as your phone and internet. Do you need every feature you use on your plans? Is there a cheaper alternative? Big savings could be possible by cutting down or eliminating unnecessary expenses.
Pay Off High-Interest Debt
High-interest debt can hinder your ability to save for a home. From student loan payments to credit card debt, interest can eat away at your down payment fund. For this reason, it’s wise to pay off your high-interest debt.
There are two major advantages of paying off high-interest debt. First, your high-interest rates won’t be eating through your income. Once these expensive debts are erased from your finances, you will be saving even faster.
Secondly, paying off debts can help increase your credit score. This is beneficial to getting a better loan offer when you do apply for your mortgage. Your credit score is an essential factor in your application. Paying off your high-interest debts is always a good idea. When it comes to homeownership preparation, it can be even more important to remove expensive debts.
Best Places to Save Your Down Payment
There are many ways to save your down payment. The easiest way is to put funds away in a savings account. There are a few options to choose from, but there are stipulations for certain account types. Here is some information on account types for your down payment.
Holding your funds in your savings account through your credit union or bank is a simple way to build savings. They’re easy to open, especially if you’re a current customer. Then you can set up recurring transfers however you’d like or transfer funds manually.
This is a secure way to save money because savings accounts are guaranteed by the National Credit Union Association (NCUA) or Federal Deposit Insurance Corporation (FDIC). The downside of this is the return on your funds is minimal as regular savings accounts have very low-interest rates.
High-Interest Savings Account
If you want a simple way to earn more interest on your money while still having the backing and protection of the NCUA and FDIC, you can enroll in a high-interest savings account. The easiest way to do so is still going through your current bank. Certain financial institutions may only allow existing clients to open these accounts.
These savings accounts pay substantially higher interest rates compared to regular savings accounts. In some cases, 10 to 20 times more. One exception here is that the highest rates are offered by online-only banks. If you are okay without having a physical location for your institution, a virtual bank may give you the best savings option.
Having said all of the above, if you aren’t currently an online banking customer, you will probably have a little longer transfer time from checking to savings. Comparing potential earnings from other investment options, online savings accounts may not be the most ideal.
First-Time Homebuyer Savings Account
First-time homebuyer loan programs are available to help those who would are considering purchasing their first home. These perks are offered in many U.S. states, and while the benefits can vary with each state, they are an incentive for purchasing a home.
As of March 2022, these states currently offer a first-time homebuyer savings account: Alabama, Colorado, Iowa, Michigan, Minnesota, Mississippi, Montana, Oregon and Virginia. A few more states are still contemplating allowing these account types soon, including Kansas, Massachusetts and Maryland. If you are in any of these states mentioned above, you may want to research this type of savings account.
Saving for a down payment takes careful planning. But, with consistency and perseverance, you can save a down payment that will help you buy the home of your dreams. While starting to save can seem daunting, knowing a few strategies can make it easier. Creating a budget, finding a side gig, paying off high-interest debt and even opening up a savings account designed for your goals can help you have a down payment in no time.
Tips to Save for a Home
- A financial advisor can help you fit a down payment into your financial plan. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- The housing and mortgage markets have been a source of volatility in recent years. Don’t go in blind – use SmartAsset’s mortgage rates table. With it, you’ll have a better idea of the market’s climate.
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