How to Save for a Down Payment on a House

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Buying a house is a huge adult move, and a really smart one! Since buying my first house in 2012, my net worth has quadrupled, and now that I have a small rental portfolio, I’m actually making money from real estate investments every month! Oh, and there’s the whole making-a-home-for-yourself-and-your-future-family bit, if you’re into that sort of thing 🙂 But one big problem: how do you save for a down payment on a house?

There are more details to consider than most people expect. But once you look at these details, you realize that actually saving the money isn’t as impossible as it might seem at first. The down payment on a house might be the single biggest expense you ever pay in your life! So yeah, the amount can be daunting. But with a basic understanding of how real estate financing works (which you’ll get from this post!), and how to create a savings plan for something this big, you’ll see it’s totally doable.

So let’s do it!

 

First, Babysit Your Credit

Wait, what? We’re just trying to save money…what does credit have to do with this process?

We have a little real estate secret for you. Getting a good interest rate is half the battle in making your home a smart investment. And how do you get the best interest rate? You need good credit.

Consider this:

You’re buying a $250,000 home. You’ve saved $50,000 for the 20% down payment thanks to this brilliant savings plan. You need a 30-year fixed loan for the remaining $200,000 (fixed just means your interest rate doesn’t change).

• If you have great credit (a credit score over 740), you can get an interest rate as low as 3.66% (as of today, according to bankrate.com – just know interest rates literally change daily).
• If you have a meh credit (between 660-679, anything less would substantially increase your rates or even disqualify you from some home loans), your interest rate could start as low as 4.16%.

Sounds like no big deal, right? Not a huge difference between 3.66% and 4.16%. But when you look at the impact over your 30 year loan, it’s a really big deal.

• At 3.66%, you’ll pay about $129,777 in interest
• At 4.16%, you’ll pay about $150,413 in interest

You can literally save $20,636 just by having good credit!

So you’ll be saving for a down payment over at least the next year, probably longer, right? Use that time wisely and build perfect credit or boost existing credit! Get it over 740 for the best rates. And if you’re not buying the property alone, make sure your buying partner also has great credit. Credit scores for all buyers will be considered in your loan application and interest rates.

 

Know Your Limits

You need at least an idea of how much house you’ll be able to afford. Like, you don’t need to save $100,000 as the down payment on a $500,000 house if you won’t be able to afford the monthly payments on that $500,000 house anyway, right?

But what is the monthly payment on a $500,000 house? That’s a hard question to answer, because it depends on a few different factors.

Your monthly payment actually consists of 3-5 different charges:

1. Principal and Interest: The amount of the loan you’re paying back plus interest. The interest portion of this number depends on market rates at the time of the purchase and your credit score. Consider our hypothetical $250,000 home. At a 3.66% interest, rate your monthly principal and interest is $916. At a 4.16% interest rate, it’s $973.
2. Taxes: Property taxes are usually only due a few times per year, but your lender needs to make sure you’re paying them, so they include this in the monthly mortgage payment and have the loan servicer pay the taxes on your behalf. Taxes are usually a percentage of the value of your home based on local tax guidelines. You can’t trust the tax info on a property listing because they only list what the current owner is paying. Your taxes on that same property will be totally different (almost always much higher). See, homeowners are protected from giant tax increases, but once a property sells, the taxes reset to the current local rate, and the new buyer pays that higher rate. Ask a local Realtor or check with your county’s tax collector for info on how your local taxes are calculated to avoid a nasty surprise.
3. Insurance: Home owner’s insurance is required by lenders. So, like with the taxes, they need to make sure you’re making the insurance payments, so they include it in the monthly mortgage payment and have the loan servicer pay it for you. It depends on location, size of the home, etc. It’s usually somewhere around $1,000/year for a middle-class house, so about $83/month.
4. PMI: PMI (Private Mortgage Insurance) is only necessary if your down payment is less than 20% of the purchase price. It’s extra assurance to your lender that you’ll pay back the loan since the lender is taking more of a risk by funding more of the purchase. This can be a few hundred per month.
5. HOA Dues: If your home is part of a Homeowner’s Association, you’ll pay HOA dues every month for the maintenance of the community (landscaping, road repairs, amenities, etc.). This amount is typically not included in your mortgage payment. You pay it separately. And it totally depends on the community. $200-$300/month is common, but check with a local Realtor to get the details on your market.

OK, now you ideally want all of those charges combined to be less than 30% of your gross income.

Example: if you make $50,000/year, you only want to spend $15,000/year (30% of $50,000) on housing. So you have a monthly housing budget of $1,250.

So now you have an idea of how much house you can afford. And you can start looking at how much you need for a down payment.

How Much Do You Need for a Down Payment on a House?

Your down payment will be a certain percentage of the purchase price of the home.

20% is ideal. If you can get to 20%, do it!

But it’s unrealistic in some markets. Our first home was a bit of a fixer-upper in LA. Even back in 2012, a 20% down payment would have been $77,000. Who has $77,000 plus money for renovations available in cash?! Especially in their 20’s? No wonder so many millennials think they can’t buy real estate.

But there are ways to get around the 20% rule.

FHA loans are a popular option. If you qualify for an FHA loan, you can put down as little as 3.5%. So our required down payment on that house in LA went from $77,000 to just $13,475. Whew! That’s much more doable!

But there’s a catch. If you’re putting down less than 20%, your mortgage lender needs some extra assurance that you’ll follow through on your mortgage payments for the term of the loan. So they require Private Mortgage Insurance (PMI).

You can pay the cost of the PMI yourself, or you can opt for Lender-Paid PMI. If you pay the PMI yourself, your home loan service provider will include this cost in your monthly payment, and they will send the PMI payment to the PMI provider. This way your lender is sure the PMI premiums are being paid and your coverage won’t lapse. If you go with Lender-Paid PMI, your lender will pay the PMI for you, but they’ll raise your interest rate to cover their cost.

PMI doesn’t have to last forever. Once you’ve made enough payments on the mortgage (and/or the value of the property increases) so your loan is down to 80% of the home’s value, you can refinance your home loan to remove the PMI.

 

Buying a House Takes More than Just a Down Payment

Your down payment on a house isn’t the only cost you’ll have to pay to close the deal.

You’ll also need to have money saved for:

• Inspections: The national average cost for a general home inspection is currently $323. You may also want specialized inspections (like mold, termite, radon, etc.), so check local rates or just talk to a Realtor about these potential costs.
• Closing costs: This is a shocker for first-time home buyers. Closing costs include things like title fees, prorated property taxes and insurance for the rest of the year, and recording fees. These fees vary greatly by area and depend on the specifics of each real estate transaction. You should be prepared to spend $2,000-$4,000 on closing costs. There are creative ways to avoid closing costs, but they will probably end up costing you more in the long-run. You can always talk to a local Realtor about local costs and options.
• Repairs/renovations: It’s smart to have a little money set aside for the small renovations and repairs you’ll want to make to even the most move-in ready house. Think changing the locks, replacing the personalized mailbox, and repainting. $1,000 – $2,000 is a good start.

Why does no one talk about these extras?!

Add it all up: down payment, inspection fees, closing costs, and estimated repair/renovation amounts. That’s your savings goal!

What’s Your Time Frame?

How much time do you have before you want to buy your home? 2 years? 10?

And how many paychecks will you get during that time? Every paycheck is an opportunity to save!

• Monthly: 12 checks per year
• Twice per month: 24 checks per year
• Every two weeks: 26 checks per year
• Weekly: 52 checks per year

Calculate Your Savings Amount

So how much do you need to save out of every paycheck to meet your goal?

It’s an easy math formula:

total savings goal / number of paychecks until goal date = the amount to save from each paycheck

Example:

Say your savings goal is $32,000, and you want to get there in 4 years. You get paid every two weeks, so 4 years is 104 paychecks away (26 paychecks/year x 4 years). $32,000 divided by 104 equals $307.69. So you would need to save $307.69 each paycheck to have $32,000 saved in 4 years.

So what’s your number?

Does it seem undoably high?

Try cutting some expenses with our 35+ Ways to Save Money. If you’re already a careful spender, maybe you need to make a little extra money. Try our $500/mo side hustles or our weird ways to make money in your spare time.

 

Where Do You Store This Savings?

The trick to savings is to have the money available when you need it, but also have it earn some interest while it’s waiting. The closer you are to your goal date, the more conservative you need to be with your money.

Here are some good rules-of-thumb for savings options by time-frame:

• Within 3 years: Keep your money as safe and accessible as possible in a high-yield savings account or money market account.
• 3-7 years: Keep your money fairly safe, but less accessible, in CD’s (Certificates of Deposit) or Bond Index Funds.
• Over 7 years: Take a little more risk with your money in the hopes of earning better returns by investing in Stock Index Funds.

If you’re not familiar with these different saving/investing options, check out our Big List of Saving and Investment Accounts for an overview.

Here’s the beautiful thing about planning ahead: the more time you give your savings to grow, the more you benefit from the magic of compound interest. If you save $307.69 every two weeks in an investment account earning 5% annual interest, your $32,000 investment turn into $35,387. You’d earn $3,387 just for keeping your money in the right account! New living room furniture for that new home anyone? 😉

Automate

Are you going to remember to transfer money to your designated Down Payment Savings every payday?

What if you need a new dress for your friend’s wedding and would really rather spend your money on that this pay period?

The brilliant-but-simple solution is to automate your savings plan. Automating is the smartest move you can make in any savings plan!

Simply login to your online banking and schedule an “auto-transfer” to automatically transfer your calculated savings amount from checking to your Down Payment Savings after every payday.

Ta-da! You don’t even have to think about your savings plan anymore! It’s going to continue to grow while you go about your life, and when you’re ready to buy your new home, your savings will be there waiting for you.

Be a Touch Flexible

Financial and real estate markets are constantly rising and falling. So if you’re planning far ahead (and good for you for doing so!), things may change a bit by the time you’re ready to actually buy.

Your credit score may change. Interest rates and home prices will change. That’s all totally normal.

Be ready to tweak your savings plan to work with the market changes as you get closer to serious home-hunting.

Word to the Wise

One last thing.

Don’t buy a house before you’re ready!

You’re not ready if you:

• Don’t have an emergency fund
• Aren’t contributing to a retirement account
• Struggle to pay all your bills
• Have high-interest debt (like credit cards!)
• Don’t have at least semi-stable income

Take care of those basic before you jump into such a big investment!

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Do you have any tips or advice for everyone saving for a down payment on a house?