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There are a lot of ways to save more of your cash for the purpose of buying a home. You can practice the art of frugality by budgeting every penny you earn so that enough cash is going towards your dream of becoming a homeowner.
But once you have a decent sized nest egg for your down payment and closing costs, you may struggle in deciding where the best place is to stash your cash until you are ready to buy to maximize your return.
There are a few financial strategies outside of your traditional savings account to consider as you save up to buy a home. Based on your needs, you may want to consider one or more of the options discussed below.
However, if this is your first home purchase, it’s important that you understand the basics of real estate requirements before you commit to your dream house.
What Should I Expect When Buying a Home?
Knowing what to expect before buying a home makes for a smoother process. There are many steps involved in securing a lender and finding the home of your dreams.
You need to keep reasonable expectations and, unless you are independently wealthy, you must realize you can’t buy a home overnight.
Ideally, you should start planning for the future as early as possible. If you are at a point in life where buying a home is a logical next step, you need to start saving as much money as you can. This ensures you can afford a home you really love without too much financial strain or buying pressure.
Start browsing the real estate ads in desirable neighborhoods to get an idea of how much home are going for in the area.
While you can ultimately negotiate a lower sales price, you need to have an understanding of how much money you’ll need to borrow in a mortgage loan to get the ball rolling.
Do the Math
Most lenders will expect you to have at least 20% of the home’s purchase price available in cash towards a down payment. If the home you want is in the $200,000 range, you should expect to put away $40,000 to qualify for a traditional mortgage.
You’ll also need to cover closing costs, which can total several thousand dollars depending on the terms of the home purchase.
Clean Up Credit
In addition to a sizeable down payment, lenders will also check your credit. If your FICO score is below 720, start working to improve your score as you continue to save for your down payment. The higher your score, the better the interest rate you’ll be offered.
While you can still secure conventional loans with a lower score, you’ll end up paying more in interest over the life of your loan.
To clean up your credit report, review copies of your report thoroughly. Check for inaccurate information about the listed creditor accounts, payments, and other details.
Report any errors to the original credit bureau that will investigate your claim and make changes on your report accordingly.
Fixing human errors can lead to a boost in your overall score and help you secure a lower interest rate on your mortgage.
Pay Off Your Debts
While you start saving for your down payment, you should also allocate cash towards paying off your outstanding debts. This increases your credit score and reduces your credit ratios that credit lenders will review before approving a loan.
If you have a lot of debt, it may be worthwhile to focus first on reducing balances on credit cards and other high-interest accounts before you start stocking away down payment money.
There are programs available to help you secure a mortgage if you aren’t able to save up the necessary 20% down payment or have a less-than-average credit score, Start looking for these programs as soon as possible as it takes time to research and apply for help.
The following options are available for mortgage assistance outside of a conventional mortgage loan.
FHA loans require a lesser down payment (3.5%) and slightly lower interest rates that conventional mortgages. You’ll need to find an approved FHA-loan provider to apply for an FHA loan and have a FICO score of at least 580.
VA loans are reserved for eligible veterans and active-duty US service members. They require no down payment and applicants must have at least a 620 FICO score to qualify.
Government Sponsored Loans
If you are looking to purchase a home in an approved rural or suburban area, you may qualify for a USDA loan. With a FICO score of 640 or better, you can receive 100% financing on your home purchase with no required down payment.
USDA loans also offer low interest rates over the life of your mortgage.
In addition to help securing an affordable mortgage through federal programs, you may also find helpful down payment assistance programs within your state that offers interest-free loans or grant money to supplement your down payment savings.
What Lenders are Looking for in a Loan Approval
While the programs above can help you secure a mortgage when you need help with a down payment or have less-than-perfect credit. However, these programs and traditional mortgage lenders still have a number of eligibility requirements you must meet.
The lender’s primary goal is to ensure you are capable of repaying the loan. Their requirements include:
Your Job Stability
Lenders prefer long-term employment with your current employer when approving a loan. During the loan application process, you will need to prove stable employment and income. Changing jobs or careers in the middle of the lending process may ultimately disqualify you for the loan.
Down Payment Ability
While the lender expects at least 20% down, you can strive to save up a higher amount for your down payment to reduce the amount you have to finance through a mortgage.
If your credit score is lower than what is expected by the lender, you may need to have more money than the typical 20% of the home’s purchase price available.
The lender will review your bank statements and income records to verify your down payment ability during the loan application process.
Debt To Income Ratio
A rule of thumb for a home purchase is based on your debt to income ratio. The cost of your principal mortgage payment, taxes, and insurance should not be more than 28-30% of your income.
Paying down other debts before applying for a home can change your debt to income ratio. Debt reduction will also help improve your credit score.
8 Ways to Save More Down Payment Money
Once you understand how much you need to save towards a down payment and closing costs, it’s time to get serious about putting your money away. Budgeting your income and expenses is the first step to knowing how much money you can afford to stash away towards your home purchase.
Tips for saving more money each month include:
1. Set up automatic deposits.
Designate a percentage of each paycheck you earn to be automatically deposited into a savings account. Since you won’t physically handle the cash being transferred, you are more likely to keep saving.
2. Increase your deposits.
As your budget permits, increase the amount of deposits when your income increases. You should also allocate budgetary funds from any paid off debts into your down payment fund.
3. Set aside bonuses.
If you receive a bonus at work or an unexpected windfall of cash, put it directly into your down payment fund. You may sacrifice the pleasure of spending the extra cash, but will be rewarded with achieving your down payment amount faster.
4. Save your change.
Your loose change can add up in a year’s time. Make it a habit to clean out your wallet and pockets of all loose change each week and throw the coins into a jar. At the end of each month, wrap the change and make a deposit into your down payment account.
5. Reduce your expenses.
In an effort to effectively save for your new home in the shortest period of time, consider reducing as many expenses as you can.
Downsize or disconnect your cable television packages. Switch to a more affordable cell phone plan. Cut out unnecessary household expenses. Be diligent about conserving water, heat, and electricity to reduce your monthly expenses.
6. Forego Entertainment.
Family and friends should be understanding of your goal to save up down payment money. There are lots of things you can choose for family fun that costs little or nothing at all.
Skip expensive celebrations for birthday parties and holidays and focus on how great family gatherings will be in your new home. Avoid dining out and other high-priced entertainment activities as you continue to grow your savings account.
7. Sell Your Junk.
As you prepare to move, it’s a good time to start clearing out the clutter. In an effort to save more cash for your new home, consider consigning or selling your unused items directly. All profit made from the sale of your clutter can be deposited directly into your savings account.
8. Take advantage of interest.
There are several interest-bearing accounts you can use to deposit your down payment money that will earn you additional cash throughout the time period you save.
Where should I stash my down payment cash?
There are several available options for saving for a home purchase down payment. A little bit of research on different accounts can benefit your financially when the time comes to choose your first home. Many of the available options are available at your neighborhood bank or credit union.
These options include:
You may already have a savings account set up but before you deposit your down payment money, make sure the account you have is getting the best interest rate.
Certificate of Deposit (CD)
CDs are FDIC-protected savings agreement with a guaranteed rate of return. You can open a CD account at your local bank. You agree to lend your funds to the bank for a specified period of time.
The longer your money remains in the CD, the more interest you will earn. This option is good for long-term down payment savings goals but if you need to withdraw your money before the CD’s maturity date, you’ll incur penalties and fees.
US Savings Bonds
If you are a year or more out from buying a home, you can invest in US savings bonds. There are two kinds, the Series I and the Series EE. Your money will be protected from inflation as you prepare for your home purchase and you are guaranteed a fixed rate of return.
Money Market Accounts
For short-term savings, you may consider money market accounts offered through credit unions and traditional banks. These accounts are insured by the bank and you’ll need to research the best rates available before opening an account.
Your goal in saving for a down payment should be to maximize your earning potential as much as possible while still ensuring your money is protected. You also want to keep your funds in an accessible account that you can withdraw from when you need it.
Make sure you understand any fees and penalties associated with withdrawing the funds, especially if you are only looking at short-term savings.
What Other Expenses Should I Expect?
In addition to the down payment amount you need to buy a home, there are other related expenses you need to consider when calculating your savings plan. These costs include:
While your lender needs to be satisfied with your ability to pay the 20% down payment money when you go to closing, you also need to submit earnest money that totals about 1-3% of the offer price on the house when you make the offer.
On a 200,000 house, you’ll need to have at least $2,000-$4,000 on hand at the time of your offer. This money will later become part of your down payment if your offer is accepted by the sellers.
A home inspector will check out the important aspects of the new home before you go to closing to ensure there are no significant issues with the electrical system, the plumbing system, the foundation, and the roof. You can use the results of the inspection report to ensure the sellers take care of details prior to closing.
Expect to pay around $500 towards home inspection fees but ask your realtor for a more accurate figure based on the home, size of the property, and location of the house.
Costs associated with closing on your new home average between 3% and 5% of the purchase price of the home. On a $200,000 home, you can expect to pay $6000 to $10,000 at closing that are not part of your initial down payment.
These include fees for:
- Real estate attorneys
- Title search
- Mortgage processing fees
- Realtor costs
In some scenarios, the seller may agree to pay some for some of your closing costs as an incentive for your purchase. Your realtor will help you negotiate these details at the time of your offer.
Whether you are moving just down the street or to a whole new area, take into consideration the various costs associated with moving when you create your savings plan.
It may be more cost-effective to rent a moving truck and do the hard work yourself. You may also consider spending a few hundred dollars to hire professional movers that will do all of the heavy lifting.
If you are moving far away from your current area, you will need to consider the cost of long-distance moving companies.
Other costs associated with moving include supplies like boxes, tape, and protective blankets. You may also have to pay rental fees for appliance dollies and other moving equipment.
Prior to inhabiting your new home, you’ll likely want to have a chance to clean up and organize your belongings. You’ll need to have utility services turned on including water and electricity before you officially move in.
You may also want phone service and cable television to be connected.
These connections may require deposits on your account, especially if you are moving to a new area and have to sign up with a new provider.
Depending on what you negotiate with the sellers, you may need to put out cash for professional cleaning equipment or services for the carpeting, draperies, and other parts of the new house before you move all your belongings in.
These expenses can cost a few hundred dollars if you do the work yourself. If you hire a professional cleaning crew, you can expect to pay more.
There are a lot of expenses associated with the purchase of a new home and the more prepared you are to pay for them, the less stressful your home-buying adventure will be.
It’s important to start as early as you can when saving for a home so you have time to explore all of your financial options and make the right decisions without added pressure and stress.
Do you have any tips on where to invest down payment money when saving to buy a home? Let us know in the comments below. Thanks for reading and happy frugaling!