How To Save For A Down Payment And How Much Money Would You Need?
One of the biggest challenges of home buying is saving for a down payment and for many people; this part of the process can be a little overwhelming. Many loans require a down payment of 5% to 20% and this could mean a big chunk of money depending on the price of the home.
What is a down payment?
A down payment is an initial payment made on the onset of the real estate purchase, it is usually stated as a percentage of the total cost of the property or the difference between the selling price and the amount of money you borrowed to buy the property. For example, if the property is priced at $150,000 and the loan is for $120,000, the down payment is $30,000 or 20%.
How To Save For A Down Payment?
Saving for a down payment can take a while to accomplish but if you do it smartly you might able to save enough money to meet the expenses of buying a home sooner than you think.
Here Are Some Helpful Tips On How To Save For A Down Payment
1. Determine How Much House You Can Realistically Afford
Before you start saving for a down payment, your first step is determining how much house you can afford. If you are not sure of your price range sit down and talk to a lender to find out how much of a mortgage you can qualify for. You can also look for an affordability calculator online to determine a reasonable range. Once you know how much house you can afford, set your sights on saving 5% to 20% of that amount.
Ideally, your housing expenses should not exceed 25% of your monthly income. If your monthly income is $4,500, you can safely allocate $1125 ($4,500 x .25) on your mortgage payment. Calculate how much your monthly payment will be for the mortgage.
It is best to put down 20% or more when buying a home because the more money you put on your down payment, the lower your monthly mortgage payment will be and you can also qualify for a lower mortgage rate. You won’t also need to pay for Private Mortgage Insurance (PMI protects the lender from you defaulting on the loan).
If you don’t have a 20% down payment, you can still buy a house with a lower down payment option but you’ll have to pay for monthly PMI.
2. Know How Much Down Payment You Need
If you are qualified for a loan up to $200,000 and you plan to buy a house priced at $180,000. With a 20% down ($180,000 x .20), your down payment will be $36,000.
If a 20% down payment is not possible in your financial situation, there are options where you can put down much less.
Here’s a list of low-down-payment programs you might qualify for:
Fannie Mae and Freddie Mac (GSE) – if qualified, you can put a down payment as low as 3%.
FHA – Down payments as low as 3.5% of purchase price. FHA loans are also easier to qualify for and have slightly lower rates than conventional mortgages.
VA – If you are active military, veteran, reservist or National Guard member, you and your family can avail this loan program. A VA mortgage requires no down payment or mortgage insurance.
USDA – USDA loans offer low rates and 100% financing to home buyers in rural and suburban areas.
3. Determine Your Time Frame Of Buying
If you plan on buying a home in the next few years, set a down payment savings goal. It’s best to start as early as you can so saving can be more manageable. Calculate how much you need to save on a monthly basis to reach it. The shorter your time frame of buying is the higher you need to save.
4. Down Payment Saving Tips
Make room in your budget. Allocate a portion in your budget to make sure your savings goal is manageable.
Automate a savings plan. The best option to save money is to save a portion of your paycheck automatically. Once you know how much you can afford to buy a home, get a portion of your paycheck directly deposited to your chosen account.
Set aside tax refunds. If you are expecting a tax refund, add it to your savings. A sizable refund together with the money you already saved could be enough to put you over the 20% threshold.
Save raises and bonuses. Rather than spend them, save any one-time income like annual bonus, gift, side income earnings so you can build up your savings faster.
Cut out and cut back. Put on hold the non-essentials like eating out, gym memberships, vacations, large purchases, and other things you don’t really need and save the money to increase your savings.
Make sure you have enough emergency fund. While you are saving money for your down payment, unpredictable expenses like car repairs or uncovered medical expenses can happen. It’s good to have a healthy emergency fund ready to weather the storm when it happens.
5. Alternative Funding Sources
If you cannot keep up saving for a down payment, you may have to look for other alternative funding sources.
IRA (Individual Retirement Account) for a first home purchase. If you are a first time home buyer, you can withdraw up to $10,000 from an IRA without penalty to buy a home. If you are married, you and your spouse can withdraw $10,000 from your individual IRAs. However, you’ll have to pay for the income tax due on the withdrawal. There’s a disadvantage to tapping into an IRA other than just the tax implications so you should consider this option very carefully. Discuss withdrawals with your tax accountant to make sure you’re proceeding carefully.
Taking 401(k) loan. Most 401(k) plans allow you to take a ‘loan’ up to $50,000 or half the value of your account whichever is less. Of course you will need to pay yourself back, with interest within 5 years. The upside of taking 401(k) loan is you won’t pay taxes or penalties on the loan amount. The downside, your ability to get a mortgage may be affected because you’ll be incurring more debt. It’s wise to ask your lender how such a loan will affect your qualification before you decide to take this route.
Borrowing money from family or friends. Depending on how much you borrow, this may have an implication to your loan qualification. Better consult with your loan officer if you’re considering this option.