A Guide to Saving for a House Down Payment

A Guide to Saving for a House Down Payment

Saving for a house down payment while renting can seem daunting, especially in this economic environment. Housing prices continue to soar, and savings accounts offer very little interest. Given these circumstances, setting aside money in a bank savings account can make the uphill climb even more challenging.

How much should you save for a down payment?

How do you save enough money as a first-time homebuyer? There are various things to consider when saving for a home down payment. Here are the main costs you need to consider:

• Down payment: The amount you put towards the total purchase price of the house. The more you put down, the less your monthly payment. It’s a myth that you must put down 20% to purchase a home. Putting down 20% will help you get approved and avoid private mortgage insurance, but it’s not required.
• Closing costs: These are fees associated with closing the mortgage loan. Expenses can range from 2% to 5% of the mortgage loan. It is important to note that closing costs are separate and will not apply to your down payment or mortgage balance.
• Everything else: Moving expenses, furnishings, remodeling, and endless trips to home stores over the weekend will quickly add up.

You don’t want to put everything you have into the downpayment, as you will still have to worry about closing costs and all the other stuff that comes with buying a house.

What is the minimum down payment on a house?

As with anything, the answer depends. The minimum down payment requirement will vary with the mortgage amount. The minimum down payment requirement also varies with the type of mortgage the borrower receives.

Conventional Loan: These loans follow Freddie Mac’s and Fannie Mae’s guidelines, but lenders may add additional requirements. Conventional loans may require a downpayment of as little as 3%, but 5% is much more common. The downpayment requirement will likely be higher if the loan is for a second or multifamily property.

Jumbo Loan: As the name implies, these loans are for more significant amounts than the conventional loan standards of Freddie Max and Fannie Mae. Because they do not meet the FHFA standards, they are uninsured and ”non-conforming” loans. Lenders that grant jumbo mortgages have a variety of lending standards, but all require much higher down payments, typically 20% or more.

FHA Loan: Receive their name from the Federal Housing Administration, the loan insurer. These loans are available for as little as a 3.5% down payment if the borrower has a credit score of 580 or better. For borrowers with a credit score between 500 – 579, the down payment requirement is 10%. Those who do not initially meet the credit score requirements for an FHA loan may refinance into one after meeting the standard.

VA Loan: These are available to active or retired military members and qualified spouses. VA loans do not require a down payment. While the loans do not require a down payment, there are other fees to consider, such as a funding fee.

USDA Loan: If the borrower is purchasing a home in a qualified rural area, they may qualify for a USDA loan that does not require a down payment. However, the borrower must put up 1% of the mortgage amount.

Home prices keep rising.

Home prices have been soaring over the past couple of years. In September, annual growth in home prices set a new record at 18.4%. When interest rates eventually climb, demand for mortgages will fall, and the housing market should cool.

Without question, the pandemic changed the housing market. People have more of a demand for space, and monetary policy made people more willing to take on a larger mortgage. When we look outside the pandemic, housing prices have increased on an annual average of 3.5% since 2000.

Average down payment for a house

The National Association of Realtors shows that the average down payment for a first-time homebuyer is between six and seven percent. However, six to seven percent can vary drastically depending on the first-time homebuyer’s location. Looking at Redfin’s latest 2022 median sales prices of different metro areas, we can estimate the required down payment for first-time homebuyers in other places:

Now that you have a rough estimate of the amount you need to save for a down payment, you can start saving money for your home payment. How much should you put down on the house?

The more you put down, the less your monthly mortgage payment. However, you must keep your emergency fund, bills, and closing costs in mind. You don’t want to get strapped during an emergency because you bought a house.

Six ways you can save money for a home down payment.

1. Put yourself on a budget—a pretty obvious one. However, being intentional with your money by setting a clear saving goal gives you a much higher chance of achieving your target. Set aside a predetermined amount of cash each month. Be proactive with your savings.
2. Downsize to save. Getting a smaller apartment to save on rent and utilities is a great way to lower your expenses. The added benefit is that a smaller place requires fewer things inside it. It is also much easier for you to move from a small apartment to a bigger house than vice versa.
3. Increase your income. Get a raise, change jobs, or find a side gig. Increasing your income is the best way to achieve your financial goals, but it can be the most intimidating. Knowing your worth and accomplishments is the surest way to ask for a raise confidently. If you don’t get it, you can better shop yourself. There is a nearly limitless number of ways to find a side gig via apps like Uber or DoorDash or websites UpWork.
4. Reduce your debt. Carrying debt is not necessarily a bad thing. However, carrying high-interest rate debt such as a consumer loan or credit card will hurt your ability to reach your goals. Focus on paying off high-interest-rate debt before you start saving for a house.
5. Get a roommate. Living alone is getting insanely expensive, especially in booming job markets. Finding a roommate will let you at least halve your rent and utility expenses. The added benefit is that roommates expand your social network, which will come in handy someday.
6. Move home—the ultimate way to save money. The savings on rent, utilities, and potentially groceries are game changers. Possibly the most shrewd move you can make to save for a home downpayment is to move back home with your parents. If you can swallow your pride, this savings method will catapult you toward your financial goals.

Where to save money for a house down payment while renting

First-Time Homebuyers Savings Account

The federal government has always sponsored homeownership in the US through Fannie Mae, Freddie Mac, and FHA and through various tax benefits for homeowners. While not recognized at the federal level, some states are using First-Time Homebuyer Savings Accounts, or FHSA, to encourage savings and promote homeownership. The benefits vary among states, but they all offer tax benefits for qualified use.

You can either open a new account at a bank or declare an existing account an FHSA. All you have to do is fill out the proper form with the state when filing your taxes. Some states, such as Oregon, require you to open an account with a bank or credit union. Just check with your state to see if you qualify and how to apply.

In Missouri, married couples can deduct $1,600, and all other filers may deduct $800 annually. Missouri limits contributions to $3,200 for married couples and $1,600 for all other filers. Other states, such as New York, are still exploring how to implement First-Time Homebuyer Savings Accounts.

Bank savings account

A bank savings account seems like the most logical choice for many saving for a home down payment. They are convenient to set up with your local bank, and you can have funds automatically transferred into the account.

The average interest rate for a bank savings account is about nothing, With a $10,000 balance, you can expect to earn less than $100 a year, which is not nearly enough to get ahead in your down payment fund. Thankfully, there are plenty of options for short-term savings.

Certificate of deposit

Bank certificates of deposit will lock your money up for six months or more and might yield around 4.00% per year the longer you lock your money up. The problem is the same as with a regular savings account, and you are well behind in matching the rate you need to meet your goal.

Independent Retirement Account

Surprising to many, you can withdraw $10,000 from your traditional IRA or Roth IRA should you meet the first-time homebuyer rules under the IRS. So, while you should generally leave money in your retirement accounts, you can use them with your overall savings strategy.

Open an investment account to save for a home down payment.

Saving for a house while renting is extremely difficult if home prices rise 3% faster than your bank savings account. The difference can add up if you need a few years or more to reach your goal, and you will have to save more aggressively or longer to buy a house.

To meet the constant rise of home prices, prospective home buyers need to be more aggressive. An investment account would allow savers to earn more towards their goal. There is a potential that you could lose money in an investment account. However, taking on this additional risk could make a significant difference in buying a house.

Investing your savings to buy a house

You need to grow your savings for a home purchase. Let’s keep things straightforward and use a simple portfolio of stock and bond mutual funds to help meet your goal.

Stocks. Stocks allow investors to hold a little piece of a corporation. Investors experience ups and downs similar to what an owner would. A stock (equity) mutual fund is a collection of many different stocks.

Buying into a mutual fund allows an investor to own many companies for a smaller cash investment. The mutual fund will enable investors to take on stock market returns while diversifying against any individual company’s misfortune.

US Treasury Bonds. Unites States Treasury Bonds are the safest investments anyone can hold. Because they are so safe, investors use them to balance out the riskier parts of their portfolios.

Now we put it all together. You need to risk some investment (stocks) to earn more than a bank savings account. The safest way to take on stock investment risk is with a diversified stock mutual fund.

However, equity risk alone would be too much to take, given your investment objective and time horizon of buying a house. To offset some stock risk, you need to hold Treasury Bonds. By holding Treasury Bonds, you give up some potential returns to avoid potentially significant and unnecessary losses.

Congrats! You now have a degree in finance.

How to invest for a house down payment

While a bank savings account is technically safer, its rate of return is significantly less than the expected price increase of homes. Bank savings accounts effectively guarantee that your savings will not keep pace with price increases. This is why you don’t want to keep your money in a bank account while you are renting and saving for a house down payment.

With the above information in mind, we can make a first-time homebuyer’s savings account with a higher expected return (and more risk) than bank savings accounts.

For example, the House Savings Portfolio consists of 60% Treasury bonds and 40% of an S&P 500 indexed mutual fund (or ETF).

Performance data shown represents past performance, and past performance is no guarantee of future results. Current performance may be higher or lower than the performance shown for illustrative purposes only.

From 1991 to now, this portfolio has only been negative three times. If we look at trailing, rolling three-year periods, the portfolio has not been negative. Said differently, the portfolio has not been negative when held for three years within the periods observed.

Over the observed period, the House Savings Portfolio returned 7.59% per year, significantly outperforming savings accounts. I must state that past performance is not indicative of future performance, but taking on some investment risk to save for a home can significantly benefit savers.

A first-time homebuyer’s savings plan

Saving up to buy your first home can be challenging. Cutting back on expenses is one thing, but making sure you get a solid return on your savings is another. While home prices climb, it makes sense to take on investment risk.

Setting up an investment account and making investment decisions can be complicated. Talking with a qualified fiduciary financial planner can help you make the best decision for your circumstances.

About the Author

Ryan Graves, CFA, is a registered investment advisor with over ten years of experience working for institutional and private clients. He owns and operates Bemiston Asset Management, which focuses on helping mid-career millennials achieve various financial goals through financial planning and investment management.

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