Updated January 11, 2018

How to Save for a House

Read more about Buying Your First Home

Saving for a house down payment takes discipline. Read on for smart tips on how to save enough money to buy a house.

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If you're thinking of buying a house, one of the first thoughts in your head is probably:

"How do I save money to buy a house?"

You need an actionable plan to reach this goal. It is not pocket change. Striving to save at least 20% for a down payment is the golden rule. On a $200,000 home, this means $40,000.

Watch Out: There are loan programs that allow smaller down payments, but they cost more in the long run. If you put less than 20% down, you will pay Private Mortgage Insurance (PMI). PMI can cost as much as 1% of the loan amount per year. On the $200,000 loan, PMI could cost you $2,000 for insurance per year. This means an extra $166.67 on each mortgage payment.

  1. What is Your Timeframe?
  2. How Much House Can You Afford?
  3. How to Save for a Down Payment
  4. Best Ways to Save for a House
  5. Where to Save Your Money

What Is Your Timeframe?

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Before you start saving, consider your timeframe. Do you want to purchase a house in the next year, 5 years, or 10 years?

Using the previously aforementioned $200,000 home, you would need $40,000 for your down payment. A longer timeframe allows for smaller savings per year. For example, to buy a house in 5 years, you must save $8,000 per year. To buy the house in 10 years, you would only need to save $4,000 per year to make the same down payment.

Your ultimate goal for down payment savings is to avoid PMI. Keep in mind that you may also need money for closing costs and an emergency fund. Whether you decide to go with a longer or shorter timeframe, there is no better time to start saving than now.

How Much House Can You Afford?

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Before you start saving, it also helps to know how much you need for your mortgage. If you plan on purchasing a home in the next few years, you can use today's income to determine what you can afford. If your income increases, your ability to pay your mortgage only improves. You do not have to stick to this number when you actually purchase a home though. If life causes your budget to change, then you accommodate accordingly. In the mean time, it gives you a concrete figure to plan around.

In our article, How Much House Can I Afford, we go into detail about how to precisely figure out what you can afford.

Our general recommendation? Spend no more than 28% of your gross monthly income on your mortgage payment.

For example, if you make $75,000 per year, you would calculate the following:

$75,000/12 (months) = $6,256 (monthly income)
$6,256 x 0.28 = $1,752 (maximum total monthly mortgage payment)

If you estimate property taxes for your area at around $5,000 and annual homeowner's insurance at $950:

$5,000/12 (months) = $417 (monthly taxes)
$950/12 (months) = $79 (monthly insurance)
$1,752 - $417 (taxes) - $79 (insurance) = $1,256 per month for principal and interest (mortgage payment)

Assuming a 5% interest rate, you can estimate your mortgage payment to be $550 for every $100,000 you borrow.

$1,256/$550 = 2.28
$100,000 x 2.28 = $228,000 mortgage

Once you know this amount, you can determine how much you want to save. This will give you the total amount of house you can afford. If you can save 20% in this example, you could purchase a $275,000 home with a $55,000 down payment.

What Is a Down Payment?

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A seller receives money from two places at closing - your down payment and the funds from your mortgage. Lenders usually refer to the down payment as a percentage. A 20% down payment means 20% of the purchase price of the home. The remaining funds you need to purchase the home come from your mortgage.

As in the above example, let's say you purchase a $200,000 home. If the lender requires a 20% down payment, you would calculate it as follows:

$200,000 (sales price) x 0.20 (down payment) = $40,000 (down payment)
$200,000 (sales price) - $40,000 (down payment) = $160,000 (loan)

How Much Down Payment Can You Afford?

The standard is a 20% down payment.

However, it does not mean you have to put that much down for your down payment. Your timeframe and ability to save determine how much you can save. There are programs that allow smaller down payments. However, with a lower percentage, you must include mortgage insurance, which will take away from how much house you can afford.

Low Down Payment Options

There are several loan programs offering lower down payment options, including conforming loans:

  • Fannie Mae offers a 3% down payment program
  • FHA loans require only 3.5% down
  • VA loans do not require any money down
  • USDA loans also do not require a down payment

For more information on these loan options, visit our article titled How Much Money Do You Need to Buy a House?

How Much Cash Do You Actually Need?

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You will need cash for your earnest money, your down payment, your closing costs, and some additional items, such as a home inspection, application fee, and credit check. You may be able to fold your closing costs into your loan, but this will result in a higher overall monthly payment.

  • Earnest money is generally a small percentage of the purchase price or a flat amount of $1000 and up, depending on your market. It is deposited in escrow with the initial written offer and is applied to the down payment. If your offer is not accepted, the earnest money is returned to you.

  • The home inspection will tell you if there are problems with the home that are not obvious to the untrained eye. It usually costs several hundred dollars. It is vital for most homebuyers. You may also want to pay for a separate termite inspection.

  • Lender fees usually are a small percentage of the loan to cover costs for inspections, appraisals, credit checks, and loan processing. Application fees can also cost a few hundred dollars. Other fees are usually due at closing and depending on the loan, may be folded into the mortgage.

Other costs to consider are taxes that would be held in escrow and HOA fees paid to the ownership of the property.

Mortgage Insurance: What You Need to Know

If you do not put 20% down on the home, you will be required to pay for mortgage insurance for many programs. The only exception is the VA loan, which are only for veterans.

Tip: With conventional financing, you can cancel the PMI once you owe less than 80% of the value of your home. You can make this happen in two ways:

  • Wait until you make enough payments to hit below an 80% LTV
  • Refinance after you know your home appreciates and you owe less than 80% of the appreciated value

FHA and USDA loans require mortgage insurance for the life of the loan. But you can refinance out of the insurance in the future if you qualify for a conforming loan.

Mortgage Rates: What You Need to Know

Buying a house is not just about the down payment and closing costs. You'll have a mortgage to pay as a homeowner in addition to other routine utilities and maintenance expenses. Mortgage rates are an important factor in how much house you can afford.

Mortgage rates can vary, depending on the term of the loan, the amount, and your credit score. It pays to shop for the best rate, but also pay attention to realistic disclosures along with advertisements of low rates. Consult with a mortgage professional to see what loans and rates may be available to you.

How to Save Money for a Down Payment

So you know how much you need to save. Now what? You could save a few dollars here and there, but that would take ages. Here are a few steps you can take to keep you on track.

  1. Create a plan. Consistency is key.

    1. Figure out what you can afford. Look at your gross monthly income and current monthly obligations. Don't forget about daily living expenses. You need an accurate picture of your money coming in and going out.

    2. Consider if you can cut back on some of those expenses. Do you have habits you can stop in order to save money each month? Common areas where people excessively spend include coffee stops, fast food runs, and shopping. Don't overlook cable bills, phone plans, or grocery bills either. Evaluate your budget to see where you can make changes.

    Tip: People often spend money without realizing how it affects their overall budget and savings plan. How much money could you save if you made coffee at home instead of stopping at a Starbucks before work? It all ads up!

    The same principle applies to eating out. Do you pack a lunch, or do you order from the local sandwich shop? Calculate the difference. The savings can be enlightening.

    Evaluate your utilities, your phone plans, and your Internet plans. Are there other options you could explore or promotions to take advantage of? Do you need the latest and greatest smartphone and the data charges that go with it?

    Another spending habit to evaluate is how much you spend on cigarettes, beer, and wine. We're not going to lecture you about the physical effects these thing have, but they do chip away at your financial health. Consider the overall cost you want to spend on these extra habits.

  2. Determine where you will save. Saving money should not take effort. Online savings accounts are often the easiest because you can transfer funds electronically.

    Note: Don't make the mistake of opening a savings account 3 towns over. You want to be able to easily deposit or electronically transfer your money. If you have to work too hard to get money into your savings account, it probably won't happen. Credit unions and your current bank are great places to start.

  3. Set up automatic savings. Through your employer or your bank, you can set up an automatic savings plan. You determine the amount and schedule the automatic deposits into your savings account or a long term savings account, such as a money market or certificate of deposit (CD). These tend to have higher interest rates than regular savings but have penalties for early withdrawal.

  4. Save your bonus money. Any extra money outside of your regular income is bonus money. This could mean actual bonuses from work or commissions. It also includes gifts from holidays or birthdays, tax refunds, or money you make from selling personal items. Immediately place this money in your savings account.

Other Sources for Down Payment Money

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Sometimes down payment funds do not come directly from your own paycheck. An IRA withdrawal, down payment assistance, and gift funds from friends or relatives are also other options.

  • IRA Withdrawal
    The IRS allows you to borrow from your IRA or Roth IRA one time. This is only for first-time homebuyers. You can withdraw up to $10,000 without any penalties to purchase your first home. This amount is per person. If you are married, both you and your spouse can withdraw $10,000. The IRA and Roth IRA have a few distinct rules:

    • Traditional IRA withdrawals require the payment of income taxes. You never paid the taxes on this money because your employer deducted it before taxes. You do not pay the 10% penalty, but be sure to keep the tax liability in mind for tax season.
    • You must hold a Roth IRA account for at least 5 years before you can withdraw the $10,000. You do not owe taxes on this money though. Because Roth IRA funds are already taxed funds, you've already paid them.

    Note: We do not necessarily recommend withdrawing funds from your retirement account. If you need to use it as a strategy, make it a last resort. Try to be creative and use the above strategies to ensure you have enough money for the down payment. If you need to borrow from your IRA, always talk to your tax professional first. He can help you decide if borrowing from your IRA is right based on the current market trends.

  • Down Payment Assistance Programs
    First-time homebuyers do have access to several hundred down payment assistance programs. The terms of the programs differ based on who provides the funds. You may receive a grant, which does not require repayment or have access to lower interest rates.

    Tip: There are also programs, such as the USDA and VA loans, that do not require any down payment. However, you have to meet specific eligibility requirements for these programs.

    • Only veterans or their surviving spouses are eligible for a VA loan.
    • For a USDA loan, you must purchase a home in a rural area and make less than 115% of the average income for the area.

  • Gifts from Family or Friends
    Many loan programs allow you to incorporate gift funds with your own money for a down payment. Before you accept a gift though, make sure you talk to your loan officer. Each program has different requirements on how much you can receive.

    Note: Gift funds need to be handled in a specific way. You cannot just take cash and deposit it in your bank account. The donor must provide a Gift Letter, which must state the date, the amount of funds, and the reason for the gift. It should also clearly state that it is a gift rather than a loan. The lender must track the funds throughout the transaction. This includes when the donor withdraws the funds and when you deposit them. The larger the paper trail, the more likely it is the lender will approve the use of the gift funds.

Best Ways to Save for a House

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  • While Renting
    Though it may feel like you are throwing money away on rent, you are, in fact, showing that you can meet a monthly payment. Try to ensure that your rent does not take more out of your pocket each month than you can afford.

    Rent to Own: Some people are able to rent a home with an option to buy. This can be a good strategy for you if you really like where you are living, if your credit score is weak and you need time to improve it or if you cannot get a mortgage now but will be able to in the future.

    When a tenant wishes to enter into a rent-to-own agreement, they put money down for an option: a one-time fee, which is not usually refundable. They have the option to purchase the property at some future point. They are not obligated to purchase. If the buyer cannot purchase the property at the end of the option, the fee is forfeited unless there is an agreement that it is refundable. The option can range between 2.5% and 7% of the purchase price. The agreement may specify that option money may be applied to the sale price at the close of the sale.

    Often, a percentage of the rent is applied to the purchase price, as specified in the lease contract. Buyers should consult with a real estate attorney before entering into a rent-to-own agreement.

  • To buy a house in 6 months

    1. Temporarily increase your income with a second part time job or working overtime.

    2. Cut your expenses by saying no to impulse buys, cutting out entertainment and extraneous expenses, and bargain shopping for groceries and clothing. Coupons and online rebate deals help for purchases you must make for necessities.

    3. Set up automatic savings.

    Get a Second Job: Here are a few ideas for temporarily boosting your income with a second job:

    • Driving for Uber or Lyft
    • Online writing services. Companies sometimes need writers to curate existing articles, edit their web content, or write small articles.
    • Tutoring. You can do this in person through a school or agency, or you can do it online.
    • Seasonal jobs. Check out retail stores during peak holiday or tourist seasons.
    • Restaurants. The pay can be low, but you can make good tips.

  • To buy a house in 5 years
    All of the above, plus some flexibility in your savings plan. It's important to bank windfalls, such as gifts, bonuses, or large commission checks. Don't forget to plan for emergencies. You need a financial cushion to keep current with expenses in case of a sudden illness or layoff.

    If you can commit to saving several thousand dollars a year over several years, you will see that your down payment savings build up, and you may be able to shorten the time you need to save for the down payment and expenses.

  • To buy a house on a low income
    There are mortgage programs for people with low income and good credit. Freddie Mac offers Home Possible Advantage, and Fannie Mae offers HomeReady. These feature low down payments and the ability to count non-borrower income or boarder income. There are also education requirements from an approved provider.

    There are additional programs listed on the HUD website, enabling teachers, first responders, and nurses to buy HUD foreclosure homes at a 50 percent discount. With an FHA mortgage, the down payment is minimal. A licensed real estate agent must put in the offer for you.

    If you have a low income, it is well worth your while to research these loan programs, which can be more flexible on sources of income requirements. But you also need to save for the down payment and closing fees.

    You may qualify for down payment assistance offered by charities, employers, and government agencies. Many who qualify for down payment assistance do not receive it because they do not know that it is available.

How Does Your Credit Score Figure Into Buying a Home?

Your credit score is an important factor when you apply for a mortgage. Lenders look at your credit history, your ability to pay your debts, your history of late payments, and your overall indebtedness. A low credit score will not only keep you from getting a mortgage, but it will also impact the choices that you have. You may find yourself ineligible for the best loans for your situation.

Tip: A high amount of credit card debt hurts you in two ways. You lose money by paying extra each month in fees and interest, and you lower your credit score, which affects your qualification for a mortgage.

If you have a high amount of credit card debt with a high interest rate, it might be a good idea for you to consider a balance transfer to a card with lower interest. If you continue to make the same payments on the new balance with a lower interest rate, you will be able to pay down the debt faster.

Related: How to Improve Your Credit Score

Where to Save Your Money

Saving for a down payment can be a short-term process. Starting 5 to 7 years before you purchase a home is still considered a short period of time.

When you invest for long-term things, like retirement, you have more ability to take a risk. If you invest in the stock market and lose it, you may have 30 or more years to make it up. You need down payment money, however, much sooner than the next 30 years. You need to invest it in places where you can access it and where you won't lose money.

We suggest savings accounts, CDs or money markets, depending on your timeframe. All other investment vehicles pose too much risk and could bring your dreams for a home crashing down.

Bottom Line

The earlier you start saving for a home, the better. Aiming for a 20% down payment will help you minimize the extra fees on your future mortgage payment. It may also help you secure a lower interest rate. Lenders look at lower loan-to-value ratios as less risky. The more you borrow, the riskier you look. Lenders adjust your interest rate accordingly.

We recommend that you start putting plans in place today to start saving for a home. Even if you won't purchase a home for the next few years, saving now saves you money later.

More from CreditDonkey:

Buying Your First Home

How Much House Can I Afford

How Much to Buy a House

More Articles in Money Tips

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