How to Save For a House was written by Jonathan Sanchez and originally appeared on Your Money Geek. It has been republished with permission.
Buying a home may be the biggest purchase a person can make. And, with home prices rising, it can also feel intimidating or even impossible, especially for a first-time home. However, there is no need to fret. If you’re wondering how to save for a house, you’re in the right place!
Before you start looking for a real estate agent, take some time to self-reflect on your current financial situation to develop a plan for success. Here are ten ways to help you save for a house and make your biggest purchase ever.
What Are the Costs When Buying a House
According to the National Association of REALTORS, the median existing-home sales price for March 2021 was $329,100. Unless you have hundreds of thousands of dollars to spend, you most likely will work with a bank to finance your home purchase. Thus, the two main costs you need to save up for are down payment and the closing costs.
A down payment is an out-of-pocket expense a homebuyer will pay when financing a purchase. The amount is usually a percentage of the purchase price, which can vary depending on the type of loan.
For example, a 10% down payment for a purchase price of $200,000 is $20,000. Therefore, a homebuyer would need to bring $20,000 when signing closing documents while the bank will finance the remaining balance of $180,000.
When financing a home purchase, there are several closing costs, such as an appraisal fee, termite inspection, and escrow fee. However, unlike a down payment, a homebuyer won’t know the exact dollar amount due until a few weeks or days before closing on the property.
Therefore, as a safe estimation, the closing cost is usually about 2% to 5% of the loan amount. For instance, homebuyers with a loan amount of $180,000 can estimate to pay about $3,600 to $9,000 in closing costs.
Although moving expenses are not as large as a down payment, it is still a cost that buyers should save up for. If you have a small family and only have small items, you can save a lot of money by transporting your family’s personal belongings in your car or a friend’s truck.
However, if you have larger and heavier items, you can rent a moving truck or hire a moving company. According to Moving.com, the average cost of a local move is $1,250 and $4,890 for a long-distance move.
How Much is Down Payment?
The down payment amount is usually a percentage of the purchase price. However, depending on the loan program, the percentage can vary. Determining which loans you qualify for is one of the first steps on how to save for a house. The requirements can change every year. So, be sure to check with a mortgage professional to get the latest details.
The federal government insures a Federal House Authority (FHA) loan. However, the government doesn’t provide the loan to homebuyers. Instead, this program allows lenders to offer a low down payment requirement. The government will ensure the loan in case the borrower stops paying.
According to U.S. Bank, the minimum required down payment for an FHA loan is only 3.5% of the purchase price. Therefore, a 3.5% down payment for a $200,000 purchase is $7,000.
A 203k loan is a subset of an FHA loan based on section 203(k) of the National Housing Act. This program follows the same rules as an FHA loan and includes rehab expenses as part of the loan. Thus, homebuyers can buy a distressed property in need of significant improvements but at a meager purchase price.
The U.S. Department of Veteran Affairs created the VA loan, which is similar to the FHA loan. This loan’s critical difference is exclusively for U.S. service members, veterans, and eligible surviving spouses.
A VA loan doesn’t require any money down nor private mortgage insurance. Additionally, a VA loan allows a seller to pay 100% of the closing costs, unlike an FHA limiting a seller to 3%. Therefore, a homebuyer who qualifies for a VA loan doesn’t have to save up for a down payment.
A USDA Loan is short for the “USDA Rural Development Single Family Housing Guaranteed Loan Program.” Like a VA loan, this program also allows a homebuyer to fully finance a home purchase, which means a down payment isn’t required.
The property must be a rural single-family home and low to moderate-income homebuyers based on the county’s median income to qualify for this program. Speak with a mortgage professional within your area to check your eligibility.
A conventional loan is a loan that is not part of a specific government program. The down payment ranges from 5% to 15%. Therefore, a 5% down payment for a purchase of $200,000 is $10,000.
Why Do People Want a 20% Down Payment?
Home borrowers that make a down payment of less than 20% are typically required to pay for private mortgage insurance (PMI). This insurance is not the same as home insurance. Instead, the purpose of a PMI is to protect a lender if a borrower defaults on their payment.
Thus, on top of the mortgage payment, property insurance, and property taxes, some homeowners will also have to pay for PMI. However, some homebuyers don’t mind paying the PMI because they prefer a lower down payment.
Some loan programs don’t allow you to remove the PMI. On the other hand, some programs will allow PMI removal when the balance is 80% of the original purchase. Homeowners can make extra payments towards the principal balance to accelerate the debt service payment. Alternatively, homeowners can refinance the property and take advantage of the house’s appreciation.
How Much Can You Afford?
Before you start looking at potential houses to buy, it's essential to know how much you can afford. The general rule of thumb is that the mortgage payment should be no more than ⅓ of your monthly household net income. For example, a person with a monthly net income of $2,500 should aim to have a mortgage payment of no more than $833 a month.
Although this rule of thumb is a quick and easy way to calculate a rough estimate of how much you can afford. Any homebuyer needs to review their financial situation in detail thoroughly. Mortgage payments can easily vary due to property taxes and home insurance and can quickly increase your monthly expense.
Where to Save Your Money
It's best to save money in a high-yield savings account, such as a money market account. Your account may not accrue a lot of interest. But, you avoid risking your savings by not putting it in an investment account, such as stocks or REITs.
10 Ways to Save For a Down Payment
1. Track Your Expenses
Before you can start putting away money for your down payment, you first need to identify and track all your expenses. Whether the cost is paying for utilities or entertainment, track it all.
With the help of online banking, you can see all your transactions in one place. Reviewing your expenses might even surprise you with some items you were unknowingly paying for. Knowing how much you spend on expenses will give you an accurate idea of how much you will have leftover from your paycheck.
2. Create a Budget
After you track all your expenses, it’s crucial to create a budget. A budget does not mean taking the fun out of your life. Instead, a budget is the best way to make sure you have enough money every month. For example, you budget $100 a month for dining out. If you already have exceeded that amount for the month, you will have to postpone any dining plans until next month.
3. Automate Savings
Creating a budget is a great way to be fiscally responsible. However, it can be tempting to spend your paycheck once it hits your checking account. To help overcome this temptation, you can set up automatic transfers to your savings account.
Talk to your payroll department to have them transfer a certain amount or percentage to your desired account. As another option, you can set up an automatic transfer with your bank. Automating your savings is a simple way to keep you honest with your savings.
4. Reduce Expenses
If you don’t have much money, an easy way to start saving is by reducing your expenses. For example, instead of buying lunch when you’re at the office, consider bringing your lunch.
Also, get rid of unnecessary expenses. That’s fantastic you signed up for a gym membership after the new year. But, if you’re not using it, you’re better off canceling it to keep more money in your pocket.
Consider living stingy and downsize, if possible. You’re not cheap. Instead, you are more intentional with your money. For example, you can trade-in your car for a more affordable vehicle or change your cell phone plan. Or move into an apartment with more affordable rent while you work on building up your down payment.
5. Increase Your Income
Aside from reducing your expenses, another way to save for a house is to increase your income. One way to accomplish this task is by requesting a raise from your employer. However, be sure to back up your request with data to justify a promotion.
If you’re unable to get a substantial raise from your main hustle, consider a side hustle to create a second income stream. Depending on your current career, you can leverage that to your advantage to make money in your spare time.
Additionally, if you have an extra bedroom to spare, you could house hack your current residence and rent out the room for extra income. Be sure to consult with your landlord before advertising for a roommate.
6. Postpone Major Activities
You might call me a killjoy, but another option to save for a house is to postpone significant activities or events, such as a family vacation or concerts. Saving on travel alone can save you hundreds and even thousands of dollars.
Remember, I said “postpone” and not “cancel.” There will always be another opportunity to live that experience. At least once you have your house, you can hang those memories in your new home.
7. Get Rid of Debt
Getting rid of debt is another way to help you buy a house. Not only does it reduce your monthly expense, but it can also make you favorable in the eyes of your lender.
According to Experian, two of the four significant factors mortgage lenders consider are payment history and credit utilization ratio. Lenders want to make sure potential borrowers have a good track record of paying on time.
Also, lenders use the credit utilization ratio to determine how much a borrower’s balance is compared to their credit limit. The lower the ratio, the more favorable a borrower, is to a lender. Therefore, it pays to pay down your student loans and credit card debt.
Additionally, lenders will also check a borrower’s debt-to-income ratio (DTI). This ratio compares how much a person owes to how much they earn a month. The better your DTI, credit utilization ratio, and other factors will help qualify you for a loan program to your advantage.
8. Save Your Windfall Income
There will be moments you’ll unexpectedly receive extra income, such as bonuses, gift money, tax refunds, and stimulus checks. Instead of splurging that surprise money on consumer products, save that extra cash in your separate savings account to help you get closer to your goal.
9. Sell Your Things
Another way to boost your savings is to sell items you no longer use. For example, if you’re no longer planning on having kids, you can sell that Spectra S2 to another mother in need. Not only can you make extra money, but you’ll also be reducing your belongings, which can have a positive effect on moving expenses.
A few options to sell your items are holding a garage sale or listing items for sale on Facebook or Craigslist. Aside from selling your TV or video game console, you can go as far as selling your barely used vehicle.
10. Pause or Reduce Retirement Contribution
It’s essential to make regular contributions to your retirement account, especially when you’re young and have time on your side. However, if you need a little more capital to save up for a down payment, you can temporarily pause or reduce your contribution to your 401k or IRA.
Keep in mind that you’ll lose the tax benefits of not contributing to these retirement accounts. Thus, it’s crucial to weigh the pros and cons of pausing or reducing your contributions. You may find more profitable avenues to save more money or may just need to extend your timeline when you can reach your savings goal.
Owning a house is a great way to create generational wealth. So, as early as now, start reaching out to various mortgage professionals. A seasoned mortgage lender can help you navigate the financing process and help identify mortgage loan programs that work well for you. They can also let you know what credit score to work towards to get a better interest rate.
While you work on saving up for your down payment, also practice budgeting for monthly payments. So, once you’re ready to make an offer and buy a home, you’ve already developed a habit.