Tips for Saving for a Down Payment

When buying a home, your down payment significantly affects your future housing costs. According to the Consumer Financial Protection Bureau, the size of your down payment can impact your mortgage interest rate, monthly payment, and need for mortgage insurance. Lenders typically require a down payment of 5% to 20% of the home’s purchase price. However, the more you can put down, the better. Here are some tips for saving for a down payment.

What is a down payment?

A down payment is a portion of the home’s total cost paid upfront by the buyer.

For conventional home loans, the minimum down payment is 3%, but the ideal is 20%. The average first-time homebuyer pays 6%. The amount you need depends on your financial situation and goals.

A smaller down payment can help you buy a home sooner but may lead to higher loan payments and required Private Mortgage Insurance (PMI). A larger down payment takes more time to save but reduces the mortgage amount, resulting in less interest and lower monthly payments. Your down payment also depends on the type of mortgage. Mortgages come with various terms, including different lengths and interest rates.

Calculate and set a down payment goal

Assess your financial situation. Poor money management can lead to trouble when buying a home.

Identify and address any financial issues, such as late payments, credit report errors, or high debt. Improving these areas will help you better prepare for homeownership.

Evaluate your income, expenses, and debt to determine how much house you can afford and estimate the down payment and closing costs.

While your lender will provide specific requirements, here’s a basic checklist to financially prepare for homeownership:

  1. Credit score: Obtain your credit report and check your score. Most lenders require a minimum score of 620 for conventional mortgages.
  2. Debt-to-income ratio (DTI): Ensure your DTI ratio meets lender standards. This ratio measures the percentage of your income used to pay debts. Most banks prefer a DTI under 36%, with an upper limit of 43%.
  3. Documentation: Gather pay stubs, tax returns, bank statements, and investment account statements.

Calculate how much you can realistically save each month. By consistently saving a set amount each month, you can estimate how long it will take to reach your down payment goal.

Create a detailed budget

Once you have a realistic savings goal in mind, it’s time to adjust your spending habits to help you achieve it. Start by creating a budget for buying a house. Identify your income sources and all your expenses. Gather details about your payroll, rent payments, utilities, transportation costs, credit card debt, and more.

Understanding your income and expenses each month will help you manage your finances better and allocate enough money toward your savings. Use our monthly budget calculator to easily visualize how much of your income goes toward various expenses.

With a clear view of your spending, identify potential areas for saving. Can you reduce dining out to once a week? Are there unused subscriptions you can cancel? Consider opting for a staycation instead of an expensive vacation.

Review your finances carefully, find areas where you can cut costs, and set a realistic timeframe for your down payment savings plan.

Remember, the more you save, the closer you get to owning your home.

Creating a dedicated savings account

Saving extra money in the same checking account you use for expenses can lead to mixing funds and dipping into your home down payment savings. Additionally, checking accounts usually don’t offer high interest rates. To avoid this, open a separate savings account specifically for your down payment. Choose an account with a good interest rate to help grow your savings.

Where you save your money matters. Since you’ll likely need these funds within five years, avoid investment accounts like brokerage accounts or mutual funds. Instead, opt for a high-yield savings account or a money market account.

You can set up automatic deductions from your paycheck. Many employers let you divide your paycheck into different accounts for direct deposit. Use this option to ensure you save a set amount from each paycheck. Direct this amount straight to your down payment savings account to avoid the temptation of frequent withdrawals from your savings.

Look into other ways to make money

If you have extra time and energy, consider adding another income stream to boost your down payment savings. This could involve picking up a side job such as freelancing, pet sitting, babysitting, or joining a gig app company like Instacart, Uber, or Doordash. You might also find a way to monetize a hobby, turning something you enjoy into a source of income. These additional income sources can accelerate your progress toward reaching your down payment goal.

In addition, receiving a sudden boost in cash can speed up your savings progress. Some windfalls are predictable, like tax refunds or holiday bonuses, while others, like legal settlements or inheritances, may come unexpectedly.

Plan in advance to allocate all or part of any windfall or extra income you receive toward your savings goal. Avoid spending these funds impulsively by setting them aside in your budget and transferring them directly to your savings account when they arrive.

Look into programs that offer assistance with your down payment

Getting down payment assistance can lower the amount you need to save for buying a home. You can find ways to purchase a home with little to no money down through various programs, including government and bank-sponsored options. These programs may be available at different levels, such as city, county, state, and federal.

Lender-specific programs can also provide down payment assistance in the form of forgivable or deferred payment loans, grants, rent-to-own arrangements, or incentives from new construction developers. However, these programs often have specific requirements, like being a first-time homebuyer, working in certain professions, purchasing in eligible areas, and meeting lending criteria like a minimum credit score.

You can also ask for seller concessions, where the seller covers part of your closing costs. However, the maximum limits depend on your loan type. Consult your mortgage loan officer to explore financial assistance options and strategies to reduce your closing costs.

Celebrate savings milestones

Saving for a down payment can feel overwhelming, so it’s helpful to break it down into manageable steps. Instead of focusing solely on the large sum needed, set smaller milestones along the way. For instance, if your goal is to save $40,000 in total, celebrate each $5,000 milestone by treating yourself to something special, like a meal or a small reward.

This approach not only breaks up the savings journey into more achievable segments but also provides positive reinforcement and motivation. It’s important to acknowledge and celebrate your progress, as it can help you stay committed to your savings goal in the long run.