August 7th, 2017 8:46 AM by Jackie A. Graves, President
Whether you’re purchasing a prefab dwelling,
building a new construction home,
or planning to fix up an older house,
you’re probably excited about the prospect of closing the deal and
so fast. Buying a home is an expensive proposition – the biggest investment
that most families ever make. While you aren’t required to cover the entire
purchase price up front, you do need to come up with a substantial cash sum
before you can close on your house.
need to worry about common closing costs such
as your home inspection,
lender appraisal, and title insurance.
Taken together, these expenses are nothing to sneeze at – depending on your
situation, they can amount to anywhere from 3% to 6% of the total purchase
price. In buyers’ markets,
you might have luck convincing your seller to pay some closing
costs, but that’s far from guaranteed.
line items are small change compared with the biggest closing expense of all:
your down payment.
it’s due at closing, the down payment usually isn’t considered a closing
cost. That doesn’t make it any less impactful, though. Your down payment
plays an important and sometimes decisive role in whether you can close on your
dream house – or, let’s be real, the best house you can afford on your budget.
is because your down payment is a key part of the offer you present to the seller. The
general rule of thumb is simple: the larger the down payment, the stronger the
offer. More precisely: the greater the down payment’s share of the total
purchase price, the more likely the seller is to accept.
the ideal down payment has been at least 20% of the purchase price. On a
$200,000 house, that’s $40,000. In recent years, smaller down payments have
come into vogue, thanks to looser underwriting requirements and growing
acceptance among sellers.
scraping together a down payment is a tall order, especially for first-time
homebuyers in expensive coastal markets. According to CoreLogic,
the average home price in California’s Bay Area topped $700,000 in 2016 – and
that figure includes relatively inexpensive bungalows in East Bay suburbs, as
well as ultra-pricey row houses in San Francisco proper.
doesn’t mean it’s impossible to save for a down payment. It just requires time
and fiscal discipline. If you can follow some or all of the following tips
and strategies, I’m confident you’ll realize your dream of homeownership faster
than you thought possible – even if it means scrimping in the short term.
figure out about how big your down payment will be.
payment size is a function of three overlapping factors: your desired initial
loan-to-value (LTV) ratio, your time horizon (when you want to buy), and local
housing market conditions. When people talk about budgeting for a future
home purchase, they generally refer to list prices: “We’re willing to pay
$300,000,” or “We can afford $250,000, but no more.”
on the matter of affordability, the most important number is the down payment
amount. If you can’t cobble together a $50,000 down payment on a $250,000 house
(or a $400,000 house, if you’re putting down less than 20%), then you can’t afford that house.
top end of your affordability range, then, is the highest down payment you can
save for within your allotted time horizon, without undershooting your target
LTV. So, if you want to buy a $300,000 house with a 20% down payment in three
years, you’ll need to have $60,000 set aside for that purpose 36 months from
course, you need to bring more than just your down payment to closing. To be
safe, assume your other closing costs will add up to 6% – near the top end of
the realistic closing cost range. On a $300,000 house, that’s another $18,000,
for a total of $78,000.
don’t completely deplete your bank account to buy your dream home. It’s wise to
have at least three months’ income in liquid savings as an emergency fund,
regardless of your near- or long-term goals. Six months is even better.
you’re looking to buy on an accelerated timetable, live in an expensive housing
market, or doubt your ability to save for a 20% down payment on an acceptable
house in your target neighborhood,
look into special loan programs with lower down payment requirements.
of the more common special loan programs are listed below. Other options exist,
so check with local, state, or federal housing authorities to learn what’s
available for families in your area and circumstances.
FHA Loans. FHA mortgage loans are insured,
but not originated, by the federal government – specifically, the Federal
Housing Administration. Known as 203b mortgage loans, they require just 3.5%
down. They can be used on one- to four-family homes and typically carry lower
interest rates than conventional mortgage loans, though your exact rate will
depend on your creditworthiness and other factors. Underwriting standards are
also much looser than on conventional mortgages – you can qualify with a credit
score below 600.
VA Loans. If
you or your spouse is a current or former member of the military, your family
may qualify for a VA home loan backed
by the federal government (Department of Veterans Affairs). On the down payment
front, VA loans are even better than FHA loans – they require no money down,
though you’re free to put money down and reduce the total amount you must
borrow. If interest rates drop after you’ve been in your house for a
while, look into VA streamline refinance
loans (IRRRL), which can reduce your rates significantly at a lower
cost than a conventional refinance loan.
Loans. If you’re buying a home in a rural or outer suburban area,
you may qualify for a USDA loan,
another type of federally insured loan designed to bring housing within reach
for lower-income country-dwellers. Unlike FHA and VA loans, USDA loans are
direct loans – they’re made by USDA itself. Use USDA’s
property eligibility map to see if you qualify.
97 Loans. Conventional 97 loans are just as they sound: conventional
mortgage loans that let you put as little as 3% down, for a maximum LTV of 97%.
They’re backed by Fannie Mae and come in different configurations, so be sure
to read Fannie’s
fact sheet before applying.
program-specific requirements, these special loans have some important
drawbacks. Perhaps most importantly, they carry private mortgage insurance
(PMI) premiums until LTV reaches 78% (though you can formally
request PMI removal at 80% LTV). In some cases, these annual premiums can
exceed 1% of the total loan value – an extra $3,000 per year on a $300,000
loan, for instance.
loans can also weaken your offer. Some sellers are reticent to sell to
first-time homebuyers with FHA or Conventional 97 loans, reasoning that their
finances may be shaky and the deal may fall apart before closing. All other
things being equal, rational sellers are likely to favor
conventional 20%-down offers over lower down payments.
few prospective homeowners realize that they could qualify for national down
payment assistance programs that can reduce their out-of-pocket down payment
costs by thousands of dollars.
abound, but the National Homebuyers Fund is
representative. Since 2002, it has provided more than $200 million in direct
grants to more than 30,000 buyers. It has a slew of grant option backed by
various institutions – you can see the requirements for the Citibank-backed
Sapphire option here,
grants may only be available in certain states and on loans of certain sizes.
Other conditions may apply as well, so it’s a good idea to contact the
organization directly and speak with your lender before assuming that you’ll
state and perhaps local governments may offer down payment assistance programs
as well. For instance, in my native Minneapolis, the
Minnesota Homeownership Center has a handy Down
Payment Assistance finder that tells prospective homeowners
about down payment financing and non-financial assistance resources available
in their areas. In California, Golden State Finance
Authority provides direct, need-based grants (with some strings
attached) worth up to 5% of the loan amount – not an insignificant sum in
pricey California metro areas like San Francisco and Los Angeles.
homeowners often face a fraught choice: pay off their outstanding
credit card balances or save for their down payments.
many folks, paying off credit card debt is a high-priority goal. Even low APR credit cards typically
charge interest rates north of 10% APR. On an average balance of $1,000, that’s
$100 in interest charges each year. If your debt load is higher, adjust accordingly.
they’re secured by physical property, mortgages almost always have lower
interest rates than credit cards, even when the borrower’s credit is less than
perfect. Faced with the choice to purchase a home at 5% APR or carry credit
card debt at 15% APR, most people would select the former.
off credit card debt isn’t always straightforward, though. Focus on your
highest-interest debt first (debt avalanche method),
even if that means putting as little as $25 or $50 extra toward your payment
each month. As your high-interest debt load shrinks, you can move onto
lower-interest credit card debt, and you’ll likely accelerate your progress
toward a $0 balance. With lower (or no) interest charges eating into your
spending and saving power, you can then direct your dollars toward your down
advent of online banking makes it easier than ever to save small amounts of
money without even realizing it. Some major banks, including Bank of America (Keep the
Change) and U.S. Bank (S.T.A.R.T.),
empower deposit account holders to save their spare change from every
transaction using apps that automatically round debit card payments up to the
nearest whole dollar and sock away the remainder in a savings account.
instance, when you spend $3.69 on your morning latte, your debit card is
charged $4, and the remaining $0.31 drops into your savings account. Multiply
that by 50 or 100 transactions per month and you’ve got yourself a nice side
a tax refund this year? Reserve a slice of it to reward yourself for all your
hard work last year – a nice restaurant meal,
a frugal weekend getaway,
a new piece of furniture for
your home. Enjoy it.
sock the rest of your refund away in your down payment fund. If you reliably
receive a $3,000 refund, spend $1,000, and save the rest, you’ll have $6,000
after three years, and $10,000 after five. That probably won’t account for your
entire down payment, but it can’t hurt.
part of your compensation package involves monthly, quarterly, or annual
performance bonuses or profit-sharing payments, apply the same logic to these:
Save a portion, then put the rest into your down payment fund.
performance bonuses and profit-sharing payments aren’t guaranteed, it’s risky
to account for them in your day-to-day or month-to-month budgets anyway. That’s
like counting your chickens before they hatch. If you don’t make plans for your
bonuses or profit shares before you know you’ll get them, you won’t miss them.
Actually, you’ll be grateful for them as they slowly but steadily grow your
down payment fund.
you need to set money aside each month is one thing. Actually doing it is
another. Set yourself a calendar reminder on the same day each month or pay
period to transfer a set amount of money – at least 5% of your take-home pay,
and ideally 10% – into your primary savings account. You can then separate the share
allotted to your down payment from your general savings or other savings goals.
Or, better yet, create a separate savings account whose sole purpose is to hold
your down payment funds.
even better than recurring savings account deposits? Automated savings
account deposits that you don’t have to remember to execute each month. Most
banks allow recurring savings transfers from internal or external checking
accounts. Examine your budget and determine how much you can afford to save
each pay period or month, and then make it happen, preferably on the same date
(or the day after) you receive your paycheck or direct deposit. Again, consider
a separate savings account just for your down
payment fund. If you’re looking to open a new account, go with one of these bank account promotions so
you can make the most of the opportunity.
can choose to pay off your credit card debt and focus your financial firepower
on saving for your down payment without actually canceling your credit
cards. The secret: cash back credit cards.
are literally hundreds of cash back credit cards on the market. Some, like Chase Freedom and Capital One Quicksilver
Cash Rewards, are practically household names. Others are more
obscure – they might be new, or issued by regional banks with zero name
definition, all offer some return on spending. More generous cards with favored
spending categories can offer as much as 5% back on a consistent basis, and
more on spending with select merchants or on certain items. Many have
attractive sign-up bonuses worth $100, $200, or even more. And most don’t charge
cash back credit card (or two, or more) won’t singlehandedly finance your down
payment. But, as long as you actually save the cash you earn and remember to
pay off your balance in full each month to avoid interest charges, it can
provide a helpful boost to your savings efforts.
certain conditions, your retirement account can serve as a
supplemental funding source for your down payment. Specifically, if you’re a
first-time homebuyer, you’re permitted to borrow up to $10,000 from
a traditional or Roth IRAwithout
penalty to fund your down payment.
isn’t free money, of course. If you have a traditional IRA, you need to pay
taxes on the withdrawn amount at your overall rate – 28% in the 28% bracket,
and so on. On a Roth IRA held for longer than five years, your withdrawal is
tax-free, because you’ve already paid taxes on the contribution.
you and your spouse both have IRAs, you can both withdraw up to $10,000, for a
total of $20,000. Depending on the projected size of your down payment, that
could be a sizable boost. And, on Roth IRAs held longer than five years, you
can withdraw tax- and penalty-free contributions in excess of $10,000,
though any withdrawn earnings are taxable at your normal rate.
you also have to consider the opportunity cost of taking that money out of your
account, potentially for years (by the time you make additional contributions
to cover your withdrawal).
can also borrow from employer-sponsored 401ks to
fund your down payment. On 401k loans, borrowing limits are much more generous:
You can borrow up to the lesser of $50,000 or half the value of the account.
That’s enough to fund a 20% down payment on a $250,000 house, or a 10% down
payment on a $500,000 house.
the devil is in the details. You have to pay back your 401k loans, with
interest – typically at 2% above the prime rate. On larger
loans, that means several years’ worth of three-figure monthly payments and
several thousand in interest charges. Plus, if you take out a 401k loan before
applying for a mortgage loan, your credit utilization ratio will spike, which
could raise your mortgage loan’s interest rate or cause the bank to think twice
about lending to you in the first place.
a general rule of thumb, 401k loans are useful in two situations: for funding
small down payments ($5,000 or less) in their entirety or as the last piece of
a multi-year, multi-source down payment funding strategy.
your take-home pay won’t get you to your down payment goal on your desired
timeframe, or you’re worried about negatively impacting your lifestyle as you
scrimp and save for your dream home, consider increasing your income by picking
up a side gig – either by taking on a second part-time job, picking up work as
an independent contractor, or exploring the many ways to make money from home.
and on-the-side money-making opportunities are virtually limitless. Your chosen
pursuits will likely depend on your unique skills and the assets or amenities
you have at your disposal. Some common ideas for monetizing your time, talents,
and physical assets include:
Freelance writing and editing
Freelance web development and design
Selling disused possessions (and downsizing in
the process) on Craigslist, eBay, Amazon, or a garage sale
Driving for a ridesharing
app such as Uber
Teaching classes through online portals such as Udemy
Growing and selling your own produce
Selling crafts on Etsy or at a flea market
Becoming a medical transcriber
Working as a virtual assistant, remote customer service representative,
or tech support professional
touched on the wonders of recurring and automated savings above, but it’s worth
reiterating that not all savings options are created equally.
you’re operating on a very long time horizon, it’s not wise to put your down
payment funds in the stock market. Stocks, ETFs, mutual funds,
and other equity instruments are vital components of retirement portfolios, but
they’re not appropriate for certain shorter-term savings goals.
Because, over shorter timeframes, market downturns can devastate savings goals.
Imagine that you put $20,000 in the market between 2005 and 2007, on your way
to an expected $40,000 down payment by 2009. Between mid-2007 and early 2009,
U.S. markets lost roughly half their value. In other words, that $20,000 sum
would have shrunk to just $10,000, assuming you added no new funds – no doubt
crushing your dream of buying a home in 2009.
the short and medium run, it’s much safer to invest in FDIC-insured instruments
such as traditional savings accounts, certificates of deposits (CDs), and money
market accounts. Though these instruments have relatively low yields –
currently below 2% APY in most cases – the risk of principal loss is
extremely low. If you want your down payment to actually be there, in full,
when you need it, save investments in
FDIC-insured accounts are your ticket.
most prospective homeowners, saving for a down payment is a medium- to
long-term prospect. Much will happen between the day you decide you want to
become a homeowner and the day your future home’s seller accepts your purchase
budgeting app can reduce the risk that you’ll get knocked off track by
unforeseen events. The world is filled with such apps, some of which are quite
lightweight – basically, glorified spreadsheets – and others of which have lots
of bells and whistles. Among the most common are:
one of the oldest and best-known of the many personal budgeting apps
available to U.S. consumers. It has a slew of capabilities designed to increase
your understanding of your personal finances, categorize your spending and
saving, and become more financially fit overall. It’s free to use, though
subsidized by sponsor ads and partner offers.
Level Money weighs
your expected monthly income against your projected monthly expenses to produce
your Spendable, the balance you can safely spend over the course of the month
without spending more than you earn. It can easily account for savings goals
such as a new home. It’s totally free.
a global personal finance app that provides a complete, intuitive picture of
your earning, spending, and saving, all in a lightweight, user-friendly
interface. Wally is free, though its developer has plans to add premium
features in the future.
your entire financial life – all your disparate accounts – to provide a total
picture of your fiscal health. It’s super easy to create goals, and a machine
learning component helps create dynamic budgets that let you know when you need
to dial back your spending in order to reach them.
house might be the single biggest purchase you ever make, but it won’t be the
only big-ticket item you ever buy. Unless you can comfortably live without a car, you’re likely to buy a new or used vehicle every
few years. If you have kids, you’ll need to budget for their education. Once
you’re ensconced in your home, you’ll probably want to make sensible improvements that enhance
its value or accommodate your growing family. And, all the
while, you need to have enough set aside for the unexpected.
one of these items, and many others not mentioned here, demand a measured,
thought-out savings strategy. As you notch small victories in your quest to
cobble together a down payment for your dream home, don’t neglect your other
goals – whether you’re aiming to reach them next month, next year, or next
By Brian Martucci - To view the original article