Saving for a Down Payment
Made up your mind to buy a home? Now what? Before you get started, you’re going to need to put together a down payment. How much do you need to save? The industry standard used to be 20% - at that level, there's no requirement to pay PMI. However, these days, most loans are available with only 3-5% down payment. Sure, you've seen ads for lenders offering 100% financing…but that doesn’t mean everyone can qualify for it. Here are some tips on saving for your down payment.
Since down payments are a percentage of the purchase price, higher priced homes will require a larger down payment. In addition to your down payment, you’ll also want to have funds to cover:
- Closing costs
- Insurance and taxes
- Inspection and appraisal expenses
- Moving expenses
- Utility deposits
- A few months worth of mortgage payments (at least)
1. The first thing you need to do is calculate approximately how much you will need to save. Multiply 3% by the average home price in the neighborhoods you’re interested in living. Now multiply 5% by the average home price. This will give you a high/low range (you can raise/lower the percentages if you are uncomfortable with a 3-5% range). For example, in order to afford a down payment on a $200,000 home, you will need to save between $6000 and $10,000. Why put down more money than necessary? There are a few reasons. Putting more money down:
- Enables you to reduce your monthly mortgage payments
- Enables you to pay off your home sooner
- Enables lenders to overlook minor issues with your credit
2. Now, decide how soon you’d like to purchase. A year from now? Two years? Three? Unless you have a tidy sum already saved or are expecting an influx of cash, you’ll need time to save up the money for the down payment.
3. Now that you have an idea of how much you will need and when you will need it, you can determine your Monthly Savings Target. This can be calculated by subtracting any Previous Savings (if any) from your Down Payment Target. Divide this by the # of Months to Purchase (use weeks, if you prefer).
Monthly Savings Target =
(Down Payment Required – Previous Savings) ÷ # Months to Purchase
4. Establish a separate account, specifically designated for your down payment savings. By separating these funds from your regular bank accounts, you’ll be much less likely to use them should the temptation arise. You may also want to choose an interest bearing account (savings, money market, etc.), depending on how soon you plan to purchase. This will allow you to get some return on your savings, while at the same time, not exposing your savings to unreasonable risk.
5. If you carry a balance on your credit cards, pay it off. Credit cards traditionally charge interest high rates. Why waste any unnecessary money on interest – pay off your debts and start saving as soon as possible.
6. Be Diligent. Always contribute your Monthly Savings Target (at a minimum) to your new down payment account. If possible, link your accounts and set up an automatic transfer of funds to make saving easier.
7. Take a look at your current spending habits and look for ways you can cut back on non-essential spending. It may take some sacrifice, but remember, it all goes towards your purchase of a home. A little saved each day can grow to be a large amount in just one year.
8. There are lots of ways to save and cut back, and it doesn’t always have to come at the cost of comfort. Make a game of it. See how much you can save each week or month and always try to match or beat the previous month or week’s savings. Here’s a list of suggestions to get you started:
- Bring coffee from home rather than buying it at Starbucks or Dunkin' Doughnuts
- Limit the amount you eat out at restaurants. Pack your lunch instead of buying it each day.
- Rent a movie instead of going to the movies. If you rent lots of videos already, consider joining a monthly subscription service such as Netflix.
- Cut back on cable movie channels
- Instead of buying new books, make use of your public library. In many cases, you can also rent videos from you local library for free.
- Walk or ride your bike to work, if practical. You’ll get more exercise and save on gas.
- If you live in a major city, take the bus or train instead of opting for a cab
- Carpool
- Shop around for a better rate on car insurance
- Wait for sales before going shopping
- Cut back on any unnecessary purchases
- Sell items you no longer want or use
- Save your pocket change and deposit it periodically
- Getting a refund on your taxes? Save it.
The key to putting the down payment together as quickly as possible is to be disciplined. Always save your minimum amount each month and strive to save more if possible. Don’t allow yourself to make excuses and save less or withdraw money from your down payment account. That will only draw the amount of time required to save longer.