Home ownership is often marketed as the cornerstone of the American dream. But it doesn’t come cheap. You need to make sure you’re financially prepared before considering buying a home, and that means having an emergency fund already in place, a steady source of income, and the ability to continue contributing to your long-term financial goals (like retirement) alongside managing your new expenses associated with your home.
If you’re determined to make it happen, awesome! But before you even start browsing through real estate listings online, you need to consider the what, why, and how of saving up for your down payment.
What You Need to Save for a Down Payment on a Home
What you need to save will depend on the value of the home you’re looking to buy. Be honest with yourself about what you can afford – and don’t forget to account for things like tax payments (based on the value of the home), insurance, regular maintenance costs, and expenses related to repairs and replacements.
The general rule of thumb is to save 20% of the purchasing price of the home. This is usually a pretty big number for most young professionals and families just starting out, but there are several advantages to striving for this percentage (which we’ll cover in a moment).
Of course, you could always save up for and buy a home in cash. Many families find this next to impossible to accomplish, but it is an option worth considering if you feel comfortable buying a foreclosure or are looking for a townhome, condo, or mobile unit. These tend to be cheaper than single family detached properties, so it might be easier to save and buy a home 100% in cash if you choose to look for lower-priced real estate.
One of the biggest benefits of buying in cash is that you’re likely to be preferred over other prospective buyers if they are financing. And you obviously won’t be paying for the cost of a mortgage via interest payments.
For the majority, however, a mortgage is likely to be in the cards and saving up for a down payment on a home is going to be a necessary step in the process.
Why You Need to Save 20% or More
Understanding what you need to save for your down payment on a home is important, but you should understand why you’re setting that savings goal, too. 20% gets thrown around as the magic number a whole lot, but why?
One of the biggest reasons is that if you put down less than twenty percent of the home’s value, you’re facing PMI. PMI, or private mortgage insurance, is an additional fee that’s part of your mortgage payment. Lenders require borrowers to purchase this insurance if they’re financing more than 80% of the purchase to protect themselves in case the homeowner should default on the loan.
The only good news here is that PMI isn’t forever; you can cancel it when you’ve paid off a certain amount of your loan or when you have a certain amount of equity in your home.
However, there are other reasons why you need to try your best to save up the full 20% for your down payment. Consider the fact that:
- you’re more likely to be approved with the lender you want; since the recession, it’s much harder to secure a mortgage than it was before 2008
- you’re also more likely to get a better interest rate if you show the lender you don’t have to finance such a huge percentage of the purchase of the property
- your monthly mortgage payments will be smaller and you’ll be paying less money in interest charges over the lifetime of your loan (both thanks to the fact that you didn’t finance so much and because you probably scored that better interest rate
How to Save 20% for a Down Payment on a Home
Okay, you get it – you need to save at least 20% before purchasing a home. But how on earth are you going to do that? It might require a lot of planning and a little sacrifice, but you can hit this magic number and start house hunting and mortgage shopping with confidence.
Let’s get one thing out of the way first: you should not be turning to your retirement accounts as your number one source of down payment savings. Shockingly, some major media outlets will advise young individuals and couples to borrow against their 401(k)s or to just flat-out withdraw money from their Roth IRAs.
You do not need to own a home so badly that you jeopardize your nest egg in order to have it. There may be some situations where this makes sense, but for the most part, you’re only going to hurt yourself financially in the long run. Turn to your other options for saving up the amount you need before even thinking about this.
Go where the rent is cheaper. If it will take you a few years to save up enough money for a down payment on a home, consider moving to a place where the rent will be less than what you pay now. It’s an instant way to come up with extra cash each month, which can then be put toward your down payment fund. If it’s possible, consider moving in with family or friends temporarily while you’re saving.
Get mean and lean with your budget. With the thought of owning your own place as motivation, look at your budget with a critical eye. What expenses can be totally eliminated? Where could you cut back to save a little here, a little there? What could you, at the very least, temporarily postpone so you can prioritize your down payment fund?
Consider less house. Envisioning a 3000 square foot (or more) mini mansion? Make saving up for your down payment easier and start considering lower-priced homes. You probably don’t need as much house as you think you do – and the bigger the house, the more time, effort, and money on a regular basis goes into maintaining it.
Earn more to save more. Super determined to make this thing happen? Take that energy and make some money with it, honey. Pick up a part-time job or start up some freelancing or consulting work on the side. Put all the extra money you make straight into your down payment fund.
Make your savings work for you. If you won’t be able to purchase a property in the next year or so, and you have a longer-term plan, make sure your savings is stored someplace where it can be working for you. Forget the basic savings account at a big bank with a .0001% interest rate. Shop around and see if a credit union can offer a high-yield account. Or stash your savings in a highly stable investment account, like a money market account with a provider like Vanguard.
It’s a big, long process that takes dedication to the goal, but you can save up for the down payment you need. Happy house hunting!
About the Author: Kali Hawlk is a freelance writer and content manager currently working on building her business and becoming a full-time solopreneur. She’s passionate about personal finance, careers and business, and all things Gen Y. An avid runner, she enjoys getting outside as often as possible when she’s not immersed in blogging and helping other small businesses build and manage their online presence. Connect with her on Twitter @KaliHawlk and visit her blog Common Sense Millennial.
Richmond Savers has partnered with CardRatings for our coverage of credit card products. Richmond Savers and CardRatings may receive a commission from card issuers.
