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Saving for a down payment can be the biggest obstacle that first-time home buyers have to overcome. But breaking the process down into smaller, actionable money moves might make it less daunting. While it will likely take a while to save up a down payment, with a couple of shortcuts and a pointer or two, you might reach your goal sooner than expected. Here are five things you can do 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. It's a common misconception that you need to make a 20% down payment on a mortgage. While putting 20% down will allow you to avoid paying for private mortgage insurance, lenders seldom ask for that large a payment.
If you've got a solid credit score and manageable debts, a lender may well allow you to borrow more and put down less. Additionally, different types of home loans have different down payment requirements.
Conventional loans. Most mortgages are conventional loans, which adhere to conforming loan standards set by Freddie Mac and Fannie Mae. These standards can make qualifying for a conventional mortgage harder. However, with solid financials, you can make a down payment as low as 3%.
FHA loans. FHA loans are backed by the Federal Housing Administration and require as little as 3.5% down. Required down payment amounts vary by credit score, however.
VA loans. Backed by the U.S. Department of Veterans Affairs, VA loans let borrowers skip the down payment. VA loans are limited to current and former U.S. service members and qualifying spouses.
USDA loans. USDA loans, which are backed by the U.S. Department of Agriculture, usually do not require a down payment. These loans are for borrowers in rural and suburban areas and can have income limits.
Jumbo loans. Mortgages that go beyond conforming loan limits are called jumbo loans. Because these mortgages can't be insured or backed the way other loans can, lenders often require higher down payments, starting at 10%.
When you're figuring out how much to save for a down payment, you'll also want to account for the other costs of buying a home. These can include closing costs (usually 2%-5% of the purchase price), moving costs and an emergency fund for home repairs.
2. Use money tips to accelerate your savings
Whatever the dollar amount, it can help to mount a multi-pronged attack. Making a few smart money moves can help you set aside a down payment faster:
Automate saving. Set up automatic transfers from your checking to your savings account. That helps make the process seamless — and maybe a little less painful. Your employer also might give you the option to deposit some of your paycheck directly into your savings account.
Save extra money. Whether you get a raise or bonus, or if we're simply talking about your tax refund, add the dough to your down payment savings rather than spending it. Having a little windfall in your savings might motivate you to grow the balance even bigger.
Drive smarter. Paid off your car? Resist the urge to buy a new ride and save the monthly payment. Still paying for your wheels? Consider refinancing your auto loan to lower your payments. If you haven't changed your car insurance in a while, compare rates to see if you could get a better deal (and put the difference toward your savings).
» MORE: See even more ways to save money
3. Keep down payment savings in the right account
You're setting aside as much as you can to meet your down payment goal, but you don't want to just leave it in your checking account. So what should you do with it?
Your first thought might be to invest it, with the hope of supercharging your return. But unless your target date for buying a home is way down the road — say, eight to 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.
Here are a few, potentially better, options:
High-yield savings accounts. These days, “high-yield savings account” may feel like a misnomer because savings account interest rates are rather low. But with easy access, total liquidity and FDIC insurance, these accounts are a solid choice for short- to mid-term savers — and they still pay more than 0.01%.
Money market accounts. A money market account can also be a good option for the short-term saver. Money market accounts are insured and offered by banks and credit unions. As with savings accounts, it takes a bit of shopping to find decent returns.
Certificates of deposit. Once you have a good-sized chunk of savings, you could open a certificate of deposit 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. The money is generally inaccessible for the term — six months, a year or even more — unless you pay a penalty to withdraw it.
While all of these options may currently have skinny returns, saving for a down payment may be more about keeping the cash out of sight and out of mind rather than scoring big interest payments. And each of these savings options can easily be set up for automated transfers from your checking account.
4. Resist dipping into your other savings
It's tempting — after all, the money's right there — but try to avoid taking from existing savings that you have earmarked for other goals. That includes:
Your 401(k). 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 will be taxed as ordinary income, with a 10% penalty if the withdrawal is taken before age 59½. While you might be able to make a 401(k) early withdrawal without penalty under a hardship withdrawal exemption (buying a house counts as an "immediate and heavy financial need," per the IRS), diminishing your retirement savings now can have substantial consequences in the future.
Your individual retirement account. First-time home buyers can withdraw up to $10,000 from an IRA without penalty to purchase a home. Of course, however, you’ll have to pay the income tax due on the withdrawal, unless it's a Roth IRA. This might sound like a good idea, but dipping into retirement accounts to buy a house can set back your life-after-work plans, and few people can afford to fall behind on saving for retirement.
5. Get help with saving for a down payment
Whether you're close to the finish line or you're having trouble imagining how you'll ever save enough, different forms of down payment assistance can help.
Look into local and state first-time home buyer programs. These programs often offer down payment grants or assistance, as well as tax credits and help with closing costs. They’re often run by housing finance agencies or through grants issued by the U.S. Department of Housing and Urban Development. Each has different requirements, though — some may have income restrictions, for example, or require you take a home buyer education course.
If you're fortunate enough to receive it, gift money from relatives or friends can provide a boost. The money must be an outright gift — not a loan — and you'll usually have to document how you got the funds. Specific rules for using gift money vary by loan program. In some cases, you may be required to contribute a minimum amount of your own funds in addition to the gift money.