Investing for Retirement…check
Student Loan Debt Reduced….check
Credit Card Balances Reduced…check
Now, what is the best way to save for a down payment?
You will need to plan ahead in order to have enough money for a down payment. It takes most people living in areas where the economy isn’t as strong like Cleveland, Detroit and Michigan an average of 5-6 years to save for a down payment on a home. Other areas where the economy is stronger it takes an average of 10 years. Thriving west coast communities can take decades for a down payment. In fact, it takes a college graduate in San Francisco an average of 30 years to save a down payment for a home.
Most people realize that they need to plan several years in advance in order to have enough for a down payment for a home. However, saving for a home is different than saving for retirement, where the funds you stash away likely won’t be accessed for many more years. When saving a down payment, you are saving a large sum of money that you’ll need to access soon. This means slowly setting aside small amounts and investing them in the stock market just won’t work when saving for a down payment.
There are few ways that you can start saving a down payment for your home. The key to saving for one of the biggest purchases of your life is diligence and patience. Keep in mind that it will take time to save enough for a down payment. This type of savings does not happen overnight.
First, determine how much you need to save.
Start by sitting down with a mortgage lender and see how much of a mortgage you can qualify for based on your salary. A good rule of thumb is that your housing expenses should not exceed 28% of your consistent salary. This should not include commissions or bonuses that are not steady income sources.
For example, if you make $60,000 annually, your average monthly income would be $5,000. You should not allocate more than $1,400 ($5,000 x .28) per month towards your future house payment. Be aware that this payment should include your mortgage principal and interest, real estate taxes, private mortgage insurance (PMI), homeowners insurance, and homeowners association (HOA) dues, if applicable. Your mortgage loan amount would be approximately $177,500 with a mortgage rate of 4.5%.
The mortgage loan of $177,500 does not include your down payment. In order to determine the down payment, take the loan amount of $177,500 divided by .80 which equals $221,875, subtract the $177,500 mortgage loan which will give you a down payment of $44,375. This amount will give you a 20% down payment on a house. You may still qualify for a loan without a 20% down payment. However, you will qualify for a better loan and pay significantly less in interest if you can come up with a 20% down payment.
Next, determine the timeframe in which you want to purchase your home.
Again, you need to be realistic. If you are earning a steady income of $60,000 per year, you will not be capable of saving $44,375 in a year. However, you may be able to $9,000 per year (or $750 per month) for 5 years to come up with a down payment. If your money is tight, you may need to extend your savings to $4,500 per year (or $375 per month) for 10 years.
Finally, save with diligence and patience.
When saving for a down payment for a home, you need to add it to your budget. You have to make sure the savings you want to do is realistic based on your income and expenses. This may require cutting back on some expenses and/or seeking ways to earn additional income.
Once you determine the amount you can save monthly, automate it. You will need to allocate a specific amount to go directly into a savings account or money market account dedicated to accumulating the funds for your down payment. It is more difficult to justify spending this money if you put it in a savings account dedicated to your future home.
In addition, bank any additional income. If you earn commissions, bonuses, or freelance on the side, put it directly into your savings account to expedite your down payment savings.
You also must plan for the unexpected. Unfortunately, life happens and sometimes savings for a down payment may take a backseat to other circumstances such as loss of employment, medical expenses, car repairs, etc. If you make sure you have an emergency fund before you start saving for your down payment, you can continue to save for a down payment even when these unexpected circumstances arise.
When saving for your down payment, avoid high-risk investments. Often people look at trying to get as much money as soon as possible. However, the higher the payoff, the more risk you have of losing your money. Keep in mind that the worse case scenario could prevent you from saving the down payment you need. Instead, you should save your money for your down payment in safe options like a savings account or a certificate of deposit. However, you should take the time to find a savings account or certificate of deposit with the highest return on interest.
Before you start shopping for a new home, be aware that saving to buy a home can be a very long process that requires time. Remain focused on the end result of being a home owner.