Tips for Efficiently Saving for a Down Payment
Saving up for a down payment is one of the earliest obstacles that a first-time homebuyer will face.
A down payment is a sum of money required upfront for any type of real estate investment. A down payment is typically 20% of the total cost of the home—a daunting goal for those who don't know where to start.
Fortunately, a few saving strategies, budgeting tips, and mortgage hacks can help you break the task up into more manageable steps. Sharpen your pencil, grab a calculator, and keep reading to learn how to budget and save for a down payment on a home.
Start Saving With a Clear Goal in Mind
Before you start, you need to know where you're going.
The first step to saving for a down payment is establishing a homebuying budget. Think about what you'll need in a property and start looking at the prices of homes that meet those criteria.
Generally speaking, the maximum mortgage you can afford would be 2.5 times higher than your household's combined annual income. Therefore, if your household earns $175,000 per year, you'll want to look at houses that cost between $350,000 and $437,500. You can, of course, go beneath that range, but try not to go over it.
The next step towards determining your financial destination is deciding what size down payment you're going to choose. The standard down payment size for a conventional mortgage is 20%. For houses in the budget established above, a 20% down payment could be between $70,000 and $87,500. It's possible to provide 3% to 5% down for a conventional mortgage, but you'll need to be an excellent candidate to avoid over-paying on private mortgage insurance (PMI).
The 20% down payment on a conventional mortgage ensures that you can avoid mortgage insurance, lower your interest rates, and boost your negotiation power. However, certain types of mortgages make it possible to provide less than 20% down payments without ending up with unfavorable mortgage terms.
Minimal down payment mortgage options include:
- FHA Loans (3.5% down payment)
- VA Loans (No down payment, military service required)
- USDA Loans (No down payment, rural location required)
Save Faster: Strategic Saving & Budgeting Tips
Some resources suggest that the only way to afford a down payment is to increase your income. This is true to an extent; higher income levels make it undeniably easier to fund a down payment.
As your income increases, your expenses increase proportionately. Extra income is great, but without strategic saving and thoughtful budgeting, high earners can still struggle to fund a down payment.
If you've already established a realistic goal with the tips above, then you can use these savings strategies to build more money in less time.
Limit Spending & Use Automation to Save Without Thinking
Cutting unnecessary costs is the best way to start saving money. There are a few ways to cut down on unnecessary spending and save more money each month. One way is to identify places where you're spending a lot on things you want instead of things you need. This means you'll need to cut back on subscriptions, avoid eating out, and only shop for essentials and carefully budgeted indulgences. A thoughtful budget can save thousands of dollars every month.
You should then set up an automatic savings plan to have the savings from your new budget sent directly to a savings account. If the money never arrives in your checking account, there's less temptation to spend it.
Choose the Right Type of Savings Account
When saving for a down payment, it's essential to have your money in the right place. There are a few different types of savings accounts, each with pros and cons regarding interest and liquidity.
General Savings Account. The simplest way to get started is with a deposit account. Deposit accounts are versatile and handy. They may be opened with almost any bank or credit union and need minor minimum deposits. Deposit savings accounts don't produce much (if any) interest, so people shouldn't expect to save their entire down payment this way. A general savings account can help you get started to graduate to an interest-earning account.
Money Market Account. A money market account is like a deposit savings account, except the amount inside the account grows with interest over time. The primary disadvantage is the need for a more significant deposit upfront. This might be anything from a few hundred dollars to more than $10,000. If the balance falls below a certain level, they may impose fees. The best interest rates for money market accounts can go above 2%, but they can require a minimum of $25,000 or more deposits.
Certificates of Deposit. A certificate of deposit is essentially a loan that individuals issue to a bank. However, this high-yield savings account can be burdened by challenging liquidity. To pursue this type of loan, the saver should anticipate not having access to the deposited funds for anywhere from several months to an entire decade. Patience is rewarded with CDs, as the interest rates typically range from 2% to 3%, and advanced strategies can help you compound interest daily on CDs.
Methods That Help You Save & Boost Credit at the Same Time
Optimizing your credit is an essential aspect of saving for a down payment. While it doesn't directly impact your down payment savings, optimizing your credit score works hand-in-hand with saving strategies. It will also ensure that you get to keep the savings of your lower down payment.
Good credit doesn't "give you" a lower down payment. It does, however, lower the insurance costs built into your monthly mortgage payment. So even if you save up for a less than 20% down payment on a conventional loan, your credit score will need to be high enough to get a lower monthly payment. Low credit scores will increase monthly payments, and you'll end up losing the money you thought you saved on your lower down payment.
You can improve your credit score and get better mortgage terms on a lower down payment by:
- Reducing your credit card utilization below 30%
- Making timely payments on all debts (especially credit cards and student loan payments)
- Disputing errors that show up as late payments on your credit report
Hard Work Pays Off: Save Smarter For Your Down Payment
From saving for a down payment to preparing for capital gains taxes, strong financial skills will serve you well throughout every step of homeownership.
Saving for a down payment on a home is challenging, but it doesn't have to be scary. You should start by having an amount of money in mind before you start saving and then cut out excessive spending to establish high-yielding savings accounts. Finally, optimize your credit score so that you can get better terms on a low down payment. These are all crucial steps to get the best value for the down payment you work hard to save.