How to Save for a House
Figuring out the financial logistics of buying a home, especially the first time around, can cause a great deal of anxiety. How will you come up with money for the down payment? How much home can you afford? In this article, we help you answer some of these questions. We’ll cover:
- How much money do you need for your first house?
- When should you start saving?
- Where should you stash your savings?
- 10 ways to save for a house
How much money do you need for your first house?
Here are the major costs to consider:
Down payment. The down payment required depends on the type of mortgage and the home price. Dan Andrews, a CFP based in Fort Collins, Colo. recommends working backward to figure out how much you need. “Look into the median house price in your intended area … then divide that amount by five to [calculate] the 20% down payment. Boom, there’s your target number to save toward.” Not sure how much home you can afford? Check out the LendingTree Affordability Calculator.
If you’re worried you won’t be able to save the customary 20% down payment, there are ways to bring less to the table. Federal Housing Administration loans allow for down payments as low as 3.5%. Even certain conventional loans offer 3% down. Eligible borrowers may not have put down anything at all with loans backed by the Department of Veterans Affairs and the U.S. Department of Agriculture.
Closing costs. Closing costs are required to complete a real estate transaction. They may include origination fees, credit report fees, appraisal fees, title search and title insurance, attorney fees, discount points, homeowners insurance and more. Closing costs can range from 2% to 5% of the home price. Closing costs may be negotiated, and some home loan products may not have closing costs at all. Learn more about no closing cost mortgages here.
Home furnishings and maintenance. Aside from the cost to buy the home, you may need funds to spruce up your new abode. Maintenance is a cost that new homeowners can underestimate. “I recommend people save 25% to 30% of the house’s value so they have [money] stashed away for projects, maintenance, repairs and furnishings,” said Andrews. Having money socked away means you won’t need to rely on credit cards and other debt when it’s time to make your house a home.
When should you start saving?
Saving several thousand dollars for a home down payment can seem like a big undertaking for first-time homebuyers. The median down payment, according to ATTOM Data Solutions, is $16,750. Putting a few thousand dollars away over a few years is going to be easier on your budget. “You should start saving as soon as you can and build in a set amount [of savings] into your budget each month,” said Shannah Compton Game, CFP and host of the Millennial Money podcast.
Compton Game, based in Los Angeles, also recommends having conversations with your parents or relatives early to see if they’ll be willing to contribute to your down payment. Some lenders do let you use gift funds for a portion of your down payment as long as you have a gift letter stating the money is indeed a gift and not money you need to pay back.
Where should you put your savings?
“A down payment is something that is a short-term type of savings so you generally want low risk. In this case, deposit accounts have an advantage because there is no risk due to deposit insurance,” said Ken Tumin, founder of DepositAccounts.com, which is owned by LendingTree. The bank or credit union you use should offer FDIC or NCUA insurance which insures your money up to $250,000. Investing money in the stock market may not be the best choice. You don’t want to have a situation where the market tanks, your investments take a loss and you no longer have the money you need to buy a home.
Money market vs. savings account. Money market accounts and savings accounts are examples of low-risk accounts you can use for short-term savings. The main difference between the two accounts is how you access money. You typically have to transfer money out of savings accounts and you may not get a debit card or checkbook. The money market account is one that may offer checks or a debit card, although, you can only make up to six withdrawals/transfers from the account per month. If you go the money market route, make sure you choose a money market account and not a money market fund. Money market funds are mutual fund investments that are not insured and can have greater risk.
“Another option is to ladder short-term and intermediate-term CDs that may pay higher rates than a savings account or money market account,” said Greg Knight, a CFP based in Oakland, Calif. A CD ladder is when you open multiple CDs and stagger them so they all hit maturity at different times. This approach can maximize the interest earned while making money more accessible. You can learn how to do CD laddering here at MagnifyMoney, also owns by LendingTree.
Which financial institution should you use? Online banks typically offer higher interest rates. Big brick-and-mortar banks may give an APY of 0.01% to 0.05% on savings accounts. Tumin points to the MySavingsDirect account, offering a 2.25% APY as of this writing. Check out other high-yield accounts at DepositAccounts. According to Tumin, the best money market account now is the Sallie Mae Bank Money Market account. It doesn’t have the highest rate, but the account has a long history of competitive rates. The account also has check-writing capability with no minimum balance requirements or monthly service fees.
Something to be mindful of when choosing an account is your withdrawal options. Some online banks don’t offer wire transfers. A wire transfer or cashier’s check may be required to close on your home. Tumin says you can still make an online bank without wire-transfer capabilities work. You just need to give yourself enough time before closing to transfer money from the account to another one that does have wire transfers.
10 ways to save for a house
Save a percentage of your household income
One straightforward way to start saving is choosing a percentage of your income to set aside each year. Here’s an example of how this can work:
Say you want to buy a $250,000 house, and you want to put down 20% or $50,000. Your household take-home income is $100,000 per year. Here’s a breakdown of how long it would take you to save $50,000 given that household income:
|Saving for a home|
|% of income saved per year||Amount saved per year||Time to $50,000 goal|
You can create a table like this for yourself to map out the savings timeline. Take it a step further by dividing the annual amount by 12 months to arrive at your monthly goal. Monthly savings goals can keep you on track throughout the year.
Track your spending
A budget is a plan for your money. If you don’t have a budget, it’s time to create one. There are steps to starting a budget and tips for sticking to it here. Compton Game suggests setting regular money dates with yourself each week to review your expenses while making sure you’re on track to save the amount you need for your new home.
Shop for better rates
Cutting back on eating out and other nonessential spending is one way to beef up your savings account. Negotiating for better rates from service providers is another area of opportunity. Do some comparison shopping every so often for services like internet, cable and wireless telephone service, said Compton Game. Call your service providers at least once a year to see if there is a more affordable plan available. Any money you’re able to save should be transferred into a savings account. Saving a few hundred dollars each month may seem small, but multiplied over several years it can really add up.
Downsize your lifestyle
If you can, consider your current housing arrangement to see if there is a way to cut costs. Taking on roommates is one way to reduce your housing expense. Switching apartments to a smaller floor plan or moving to a more affordable complex is another way to save. “If possible, move back home with your parents or other family if they are willing to support you in your goal,” said Knight. Knight also suggests selling items that you no longer need or use like your car, bike, motorcycle, sporting goods, fitness equipment and anything else that has a good resale value.
Use savings apps and savings account features
If saving isn’t your strong suit, there are quite a few automated savings apps that can help you put money away, including Digit and Qapital. Digit connects to your bank account and uses an algorithm to look at your deposit and withdrawal trends to see what money you have to spare. The app will take the spare cash and automatically put it into a Digit savings account. The fee for Digit is $2.99 per month.
Qapital works a lot like Digit except it has a few more savings options. For example, Qapital has a roundup feature where it rounds up your transactions and saves the difference.
In addition to third-party apps, you may be able to log right into your own savings account to utilize similar features offered by your bank. Many accounts have an automatic transfer option where you can schedule automatic deposits from checking to your savings account.
Squirrel away your tax returns, bonuses, commissions and cash windfalls
Your annual tax return can mean a large sum of cash is coming your way at the end of the year. Instead of planning a trip to Bora Bora, put this money toward your new home. Or, “You may need to adjust your W-4 withholding allowances so that refund money actually shows up monthly,” said Knight. In other words, instead of overpaying taxes throughout the year resulting in a tax refund, pay less in taxes each pay period and sock away those savings during the year.
Knight suggests pulling out of a copy of your most recent pay stub and heading over to the IRS Withholding Calculator to determine what your withholding should be. Any additional money you get each month from changing the withholding should be automatically transferred into your savings account. This is something you may want to discuss with a tax professional. You don’t want to end up not paying enough and getting a tax bill.
Work bonuses and commissions should go into the savings for your home as well. Savings should also take priority if you receive any windfalls of cash from settlements or insurance policies.
Consider your retirement accounts
Taking money from retirement accounts should be done with caution. According to Andrews, if you let yourself see retirement accounts as piggy banks, you can find ways to justify taking from your retirement account often, which can derail your retirement plan. Money you withdraw before retirement age may be taxed and there can be a 10% penalty.
You can potentially avoid these costs if you borrow from your 401(k) instead of taking a regular distribution. Generally, you can borrow $10,000 or 50% of your vested account balance, whichever is greater. The cap is $50,000. The loan repayment term is typically up to five years but may be longer when you’re using funds for a house. If you lose or leave your job, you may be required to pay the loan balance off in full.
A better option could be taking money from an IRA. You may be able to receive a distribution of up to $10,000 from a traditional IRA without a penalty as long as you’re a first-time homebuyer. This is not a loan. If you and your spouse are both first-time homebuyers, you can both get up to $10,000 without paying a penalty. You can also withdraw up to $10,000 from a Roth IRA penalty-free as long as you’ve had the account for over five years.
The advantages: Tapping into your retirement fund can help you purchase a home faster. If you find a home you love or you want to take advantage of low interest rates, taking money from retirement can get you the funds you need without having to save.
The disadvantages: Taking from retirement can be a retirement savings setback. The 401(k) loan is giving you yet another monthly bill to pay. If you can’t satisfy the terms of the 401(k) loan, you’ll have to pay income tax and penalties as if it’s a distribution and not a loan. The rules of withdrawing from a retirement can get a bit confusing. Knight suggests working with a financial planner before withdrawing from an investment account so you fully understand the implications.
Bring in more income
If your current income isn’t enough to save at the rate you want, side hustling can help you reach your homebuying goal faster. You can get creative with your side hustle or do something simple like ride-sharing, babysitting or tutoring. Flipping free or cheap items you find on Craigslist can even be lucrative.
Get a better savings account
Keep optimizing your current savings to earn the best possible return. Check your bank’s interest rates regularly to make sure they’re keeping pace with competitors. The Federal Reserve raised the Fed funds rate this year, which has a rippling effect on consumer accounts. While this may not be the best news for the interest rate on your upcoming mortgage, it can be good news for savings. As the Fed funds rate goes up, savings account rates may go up as well.
Speak with a professional
Lastly, you don’t have to go about financial planning on your own. If you need help saving and preparing for a home, you can speak with a financial planner. Many are fee-based and willing to work with people who don’t have millions of dollars in assets.
Besides saving for the down payment, becoming a homeowner will come with additional expenses and financial responsibilities. A financial planner can help you tackle outstanding debt and make sure you’re in the best possible position to take on a home.
The sooner you start the better
When the down payment amount you need is close to half your annual salary, saving up can feel next to impossible. But with time and patience, you can save up the money you need for a home.
This article may contain links to MagnifyMoney and Deposit Accounts, which are subsidiaries of LendingTree.