When buying a new house, paying a big down payment can save you a lot of money in the long run because you do not have to pay for an expensive mortgage every month. Here’s how to save for a down payment the smart way.
This means slowly setting aside small amounts and investing them in the stock market, but that is more you can do.
With these steps, we’ll cover how to start smart saving for this purchase.
Figure out how much you’ll need to save
Before you begin saving money for a down payment for a new house, you first have to know how much you’ll need to save. Plan to sit down with a mortgage lender who will let you know how much of a mortgage you can qualify for.
Generally speaking, your housing expense should not exceed 30 percent of your stable monthly income. So if your income is $10,000, you can safely allocate $3,000 of that ($10,000 x .3) to your future house payment.
This expense will include mortgage principal and interest, real estate taxes, private mortgage insurance (PMI) if you pay a downpayment less than 20 percent, homeowners insurance, and homeowners association (HOA) dues, if any.
To arrive at the amount that you can afford to pay for a house, you’ll have to add the down payment on top of that. In today’s tight lending market, you should expect to make a 20 percent down payment on a house. This is just the minimum down payment to get the best-priced deals.
You can certainly put down less, but you will likely be paying a higher rate and, if you have any kind of credit issues, you may not be able to get a mortgage at all.
So taking this example, there is a mortgage for $250,000, and let us make a provision for a 20 percent down payment, we can calculate the amount this way:
$250,000 multiply by 80 percent = $200,000, minus the $50,000 mortgage downpayment
You’ll be purchasing a house for $250,000, with a $200,000 mortgage, and a down payment of about $50,000.
Don’t get hung up on those calculations– a mortgage lender can perform the same calculations for you based on your own financial circumstances. We’ve done this for illustration purposes only, and so that we can carry that $50,000 number forward for more calculations.
Find out when you will buy the house
The next step is to find out when you need to move to your new house. If you plan on purchasing a home valued $250,000 in five years, you’ll have to be prepared to save $10,000 per year ($50,000 divided by five years).
Naturally, the shorter your time frame is, the higher your annual savings goal will be.
Find the best way to save for your down payment
As a rule, since the money that you are saving for the down payment on a house has a definite purpose, and needs to be reached within a specific time frame, you should not save money in risk-type investment like stocks, real estate investment trusts, and etc., Instead, you should save your money in super-safe investment like a savings account or a certificate of deposit.Sure, you may be able to earn more money by investing your down payment account in higher risk investments, but there is also the very high risk that you will lose money in the process.
Make room in your budget
Since we’re talking about saving thousands of dollars per year, you have to clear some room in your budget to make sure that your savings goal is realistic. That means you may have to earn additional income, cut back on expenses, or both.
But, by making room in your budget can help you save the kind of money you’ll need for your down payment, another benefit is this will prepare you for managing the type of tighter budget that home ownership requires.
Set up an automated savings plan
Unless you’re a saver by nature, you’ll need to automate the savings process. That will mean some sort of payroll savings plan. Just like your 401(k) plan, you should allocate a certain percentage or dollar amount of your regular pay to go directly into a savings account or roth ira account dedicated to accumulating the funds for your down payment.
Not only does this make the process automatic, but it also makes it invisible. Money moves from your paycheck to your dedicated savings account without you even seeing it happen. That will remove both the temptation and ability to spend the money on other purposes.
Bank those windfalls
You can make the process of saving money for a down payment on a house easier—or even shorten the process—by banking periodic windfalls. These can include income-tax refunds, gifts received, bonuses or large commission checks, or even the sale of personal assets.
By depositing these funds into your down payment savings account, you fast-forward the process of saving money to buy your future home. Regularly depositing in your bank account can speed up a couple of years off of your savings time frame.
Build flexibility into your savings plan
Whatever the size of your down payment, it is important to build flexibility into your savings plan.
While you’re saving up money, there’ll be other demands on your finances. These can include major car repairs, replacement of a car, uncovered medical expenses, or even a job firing. None of these will magically stop just because you have a goal of saving money for a down payment on a house. You’ll have to be ready when they happen.
Make sure that you have an emergency fund—before you even start saving for your down payment—and keep it well supplied. And if you have predictable expenses, such as replacing your car, you’ll need to simultaneously prepare for that expense as well.
Buying a home can be a long process that requires a good chunk of your savings, but think of it all as preparation for home ownership. You’ll have all of those expenses after you buy your home too, but you’ll also have large expenses related to the home itself. So think of this as a way to prepare your finances and for the extra expenses that home ownership brings.