How to Save for a Down Payment

First, know how much down payment you'll need. Then, automate your savings with direct transfers and use small saving hacks that will add up over time.

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Saving for a down payment to buy a house can seem overwhelming unless you break it down into small, actionable moves. It will likely take a while to accomplish, but with a couple of shortcuts and a hack or two, you might reach your goal sooner than expected.

Here are five tips to get started.

1. Determine how much to save for a down payment

The down payment is the upfront cash you pay to get a home loan, and it's expressed as a percentage of the home price. The required down payment depends on the type of mortgage and the lender. FHA loans, which are backed by the Federal Housing Administration, require as little as 3.5% down. VA loans, backed by the U.S. Department of Veterans Affairs, have no down payment requirement. And some conventional loans, which are not backed by the government, require as little as 3% down.

However, you typically need to put down at least 20% to avoid paying for private mortgage insurance on a conventional loan. Mortgage insurance protects the lender in case the borrower defaults on the home loan.

2. Use money-saving hacks for a down payment

Whatever your down payment goal, it can help to mount a multi-tiered attack. Here are some saving hacks:

  • Automate saving. Set up automatic transfers from your checking to savings account. That helps make the process seamless — and maybe a little less painful.

  • Save raises and bonuses rather than spend them.

  • Set aside tax refunds.

  • Stash away spare change.  A variety of banks and savings apps have variations on this theme. For example, some banks allow debit card users to sign up for a service that rounds up purchases to the nearest dollar and puts the change into a linked savings account.

  • Use cash rewards credit cards. Get cash back on purchases and put the rebates in savings.

  • Keep the car and save the payment. Paid off your car? Resist the urge to buy new and save the monthly payment. Still have an auto loan? Consider refinancing it to lower your payments.

  • Refinance your student loans. Lower your student loan interest rate to save on the total cost of your loan. If you qualify, you could save thousands to put toward your down payment.

  • Start fast, and the momentum will build. Seed your down payment fund with a bonus or other windfall. A quick start might motivate you to see the balance build even bigger.

  • Visualize your goal. Slap big, beautiful photos of your dream house on the refrigerator, near your office workspace — and wrap a small one around the primary credit card in your wallet. You might charge less and save more.

3. Get help with saving for a down payment

Investigate state first-time home buyer programs that offer down payment grants or assistance, as well as tax credits and help with closing costs. These programs are often run by Housing Finance Agencies or through grants issued by the U.S. Department of Housing and Urban Development (HUD).

Gift money from relatives or friends can provide a big boost. The money must be an outright gift — not a loan. The rules for gift money vary by loan program. In some cases, you may be required to contribute some of your own cash in addition to the gift money.

4. Keep down payment savings in the right account

Now that you have a plan to save for your down payment, where do you put the cash? Your first thought might be to invest it, with the hope of supercharging your return on what may be a meager starting balance.

Unless your target date for buying a home is way down the road — say eight, 10 years or more — don’t do it. The stock market is too volatile for short-term savings. One severe market downturn can set you back significantly, not to mention discourage your ongoing efforts. Instead, take a look at these options:

High-yield savings accounts: These days, “high-yield savings account” is a bit of a misnomer because savings rates can be rather low. But with easy access, total liquidity and FDIC insurance, it’s a common choice for short- to mid-term savers. Banks, especially online versions, offer decent rates. Be sure to check with your local credit unions, as well.

Money market accounts and funds: Money market accounts and funds can also be good options for the short-term saver. Money market accounts are insured and offered by banks and credit unions, while money market mutual funds are not insured and are available at investment brokerages.

As with savings accounts, it takes a bit of shopping to find decent returns.

Certificates of deposit: Perhaps the best option is buying certificates of deposit (CDs) timed to mature around the time you expect to have the bulk of your down payment saved. CDs offer a slightly higher rate than savings accounts or money markets, but that’s because your money is locked up for the term of the CD: six months, one year — even two, three years or more.

The fact that your money is inaccessible unless you pay a penalty may help keep those easily tempted to tap savings on track.

While all of these options may currently have skinny returns, as interest rates rise, your profits will too. Besides, saving for a down payment may be more about keeping the cash out of sight and out of mind rather than scoring big returns. And each of these savings options can easily be set up for automated transfers from your checking account.

5. Resist dipping into retirement savings

First-time home buyers can withdraw up to $10,000 from an IRA without penalty to purchase a home. Of course, you’ll have to pay the income tax due on the withdrawal, unless it's a Roth IRA.

That might sound like a good idea, but dipping into retirement accounts to buy a house can set you back in your life-after-work plans, and few people can afford to get further behind.

Taking a loan from a 401(k) is risky. If you lose your job, the loan must be repaid by the next tax filing deadline, or it's taxed as ordinary income, with a 10% penalty if the withdrawal is taken before age 59 ½.

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