How to Save Up for a Down Payment
Let's start with some great news: You DON'T need 20% down to buy a house. In our market, here in Raleigh, North Carolina, and in a lot of other places, you can buy a home with 0% down
A great way to build wealth over a period of time is through the building of home equity. Obviously, this means that one of the main requirements needed to build this home equity is to actually own a home. Many aspiring home buyers typically run into the problem of acquiring the funds needed to make their first down payment on a new home. Not a problem. This article lists the many steps a person can take to save up the money needed to do just that.
More than likely, one of the biggest single purchases an individual will make during their lifetime will be purchasing a home. When dealing with the prospects of buying real estate, understanding the full ins and outs of the process should be of the utmost importance. Being aware of the total cost of everything, along with what you can afford, will put you in a great position. This will enable you to properly prepare for your future purchase.
At the time of closing the deal on your new home, there will be a one-time payment made in cash referred to as a “down payment”. Being as though your mortgage payments each month, as well as the initial value of your home equity, is determined by your down payment, it’s crucial to understand the long-term financial effect it can have on you and your budget.
Buying a home is not for everyone. In my local market, Raleigh, North Carolina, you really shouldn't be afraid to pull the trigger on a house. If it's anywhere near a decent deal it's going to be a good investment. A lot of people want to buy a home and will never execute because they're afraid to pull the trigger or making a mistake. It's a lot harder to make a mistake in a strong market like we have in Raleigh.
You should think about your timeline when trying to decide if renting or buying is the best option for you. One well-known concept and rule to live by is that in order to reconcile all transaction fees and closing costs associated with purchasing a home is that you must own it for about 5 to 7 years. It should go without saying that since prices and costs vary from one location to the next, the time exact time frame will depend on the area you choose to reside in. In order to assist with figuring out the costs between renting and buying, numerous online calculators have been created that can be used completely free. You should take advantage of these to gain great insights that can be beneficial in helping you decide on the best course of action.
One little-known fact is that the actual seller can decide to pay for the closing costs. How much they actually pay can vary, but it isn’t uncommon to find sellers who actually pay the entire closing cost, or at the very least, a portion of it. This will help you, as the buyer, recover any costs you had to pay in a shorter time span.
It’s important to keep this one fact in mind: The bigger the amount of your down payment, the more money you’ll likely save long-term. To save up for that bigger down payment the smart way, follow the tips that follow.
Decide on a Goal
The first step you should take when you to start to save up for that down payment is figuring out exactly how much you’ll need. Make an appointment with a mortgage lender. He or she will not only tell you the amount that will be needed as a down payment, but they’ll also be able to educate you on how much you’ll be able to prequalify for in regards to a home loan.
As a rule of thumb, after calculating your monthly income, the expenses for your house should not be greater than 28% of that. With an income of about $5,000 every month, about $1,400 should be set aside as part of your future down payment. If you didn’t understand the math, $5000 x 28% = $1400.
The $1,400 is made up of a variety of things such as interest incurred on the mortgage along with the mortgage’s principal amount, PMI also referred to as Private Mortgage Insurance, HOA fees (Home Owner’s Association) if applicable, taxes for Real Estate, and even Homeowner’s Insurance.
Figure Out Your Timeframe
Next on the list of steps is to figure out your timeframe.
Keep in mind that since you’re saving this money for a specific purpose, it shouldn’t be saved in any type of other investments if your goal is to buy a house. Store your funds in a separate bank account if it will help you avoid the temptation of withdrawing.
We are aware that you’ll be able to obtain a higher return on your money by investing in things such as stocks and real estate, but doing so exposed you to unnecessary risks. You don’t want to lose all of the money you’ve been saving up for so long. You want to buy a house. It’s ok to miss out on those potential returns because you’ll also be missing out on those potential losses as well.
Allow Room in Your Budget
Considering that we’re talking about putting thousands of dollars to the side every year, it’s necessary to create a budget that will allow you to do so. This might even require gaining some type of extra income, lowering your expenses wherever possible, or possibly both.
This may require you to get rid of some of your expenses completely. This can be a good thing because not only will it assist you in saving your down payment money, but it’ll also get you accustomed to the dealing with the tight budgets that many homeowners have to work with. You’ll me more prepared than expected when the time comes.
Create an Automatic Savings Plan
If saving money isn’t your specialty, automating the process will come in handy. With the assistance of payroll saving plans such as 401(k)s, you can have a specified dollar or percentage withdrawn you’re your paycheck into the account effortlessly. There are also other accounts such as regular savings and Money Market accounts that your money can be directly deposited to from your paychecks that can be used to build your down payment savings.
The great thing about this process is that it’s completely hands-free after the initial setup. What makes it so effective is the fact that you don’t even see the money, so you don’t miss it from your paycheck. This “invisible” savings make it easier to continue to do so. The desire to spend the funds you should be saving is pretty removed from your mind.
Save All of That Extra Cash
The process of saving the down payment money can become easier, along with the timeframe becoming shorter, by saving all extra cash received. Make a habit of adding all extra income to your down payment savings such as tax refunds, commissions, bonus checks, lottery winnings, cash gifts, etc. You’ll be happy you did in the long run.
You’d be amazed by how fast that down payment accumulates when you follow this tip. Don’t be surprised to find out that you’ve actually managed to knock a few years off of your previously calculated timeframe.
Make Sure Your Savings Plan Is Flexible
Regardless of how much your down payment is, you’ll want to be certain that your savings plan is flexible. Life throws plenty of unexpected situations. These can have a huge impact on your budget and finances. Things such as medical emergencies, car problems, loss of employment, and even family matters can cause a hit to your funds. Just because you have goals you are trying to reach doesn’t mean life won’t throw some unexpected situations your way. Make sure there’s a spot in your budget dedicated to these exact situations.
As long as you manage to prepare for these potential issues in advance, you’ll be able to deal with them as they come without being deterred from your goal of saving for that down payment. The problems will get solved and your down payment funds will continue to grow. No matter what the unexpected issue is, you’ll still find yourself in a win-win position. Just remember to make sure this part of your budget always has funds.
In all reality, this is nothing more than preparation for being a home owner. All of your current expenses will still exist when you buy a home. You might even have some additional home-related ones as well. By practicing this tip now, you’ll be more than capable of handling them just as well with the added responsibilities of homeownership.
Determine What You’ll Be Able to Afford
Common sense would tell you that prior to starting your search for a home, you should know what you’ll be able to afford. Don't be afraid of talking with a mortgage lender. After determining that, then look to see if you can find what you’d like in that price range.
To figure out what’s affordable, remember to factor in all of the previously mentioned costs and fees such as Homeowner’s Insurance, Gas, Water, Electricity, Real Estate taxes, mortgage payments each month, etc. In the event that you’re a part of a couple or will be sharing the expenses with someone else, it’d be a good idea to find a home you like that’ll you be able to have all of the expenses taken care of with just one paycheck. Bankrate has created a calculator that will assist you figuring out what you’ll be able to afford.
Websites such as Zillow.com can help you find homes in your price range in your desired area. You can also seek out the help of a trusted real estate agent. Being as though homes can vary anywhere in price from, $100,000 up to the millions, affordability will be determined by your current income as well as your savings.
Using Your IRA to Purchase Your First Home
First time home owners can actually receive a certain tax break from the IRS. You’re allowed to withdraw up to $10,000 from your IRA in order to purchase or build your first home for you and/or any of your loved ones at any age completely penalty free.
One thing that should be remembered is the $10,000 cap is a lifetime one. It’s not per year. If married, both spouses can use the $10,000 cap. This equals $20,000 between the both of them. One of the stipulations is that you’d have to make use of the funds within 120 days of withdrawing it.
Another thing to take note of is that there are two types of IRAs. One is a traditional IRA and you’ll be required to pay taxes on any funds you withdraw from it. The other is a Roth IRA. This type of IRA allows you to withdraw funds completely tax-free. Because it’ll be tax-free, the account must be open for at least 5 years before you withdraw funds from it.
It's highly recommended to discuss IRA withdrawals with a certified tax professional prior to taking any funds out of it. They can provide you with all of the pros and cons associated with it and advise you on the proper course of action you should take.
Building Wealth Through Building Equity
You’ve finally managed to accumulate those funds needed to make the down payment on that new home. Congratulations! You are officially a homeowner now! The next thing to make sure you understand is that you’re now in the process of building equity.
As you make more and more mortgage payments, you’ll acquire more and more property. Not only will your property value go up, your equity will increase as well. Because of this, in the event you decide you’d like to sell your home, you’ll probably have a down payment that’s larger than the initial one that you started out with. This is one of the ways that you’ll be building your wealth.
Final Thoughts on Saving for a Down payment
One of the more difficult parts of buying a house is having enough cash to ensure you can afford both the down payment as well as the closing costs. If you have limited funds you can still buy a house you just have to be more strategic about which loan program you use, as well as how you structure the deal for the sellers. There are a lot of great programs for first-time buyers.
There are a lot of ways in which the sellers can contribute funds to your closing costs in the form of cash back at closing. A lot of buyers will utilize this strategy when purchasing a home with limited funds because it allows them some breathing room after they move in.
Hi there! I'm Ryan Fitzgerald, a REALTOR in Raleigh-Durham, NC and the owner of Raleigh Realty. Chances are you and I share a similar passion, Real Estate! I also have a passion for building businesses, working out, inspiring others, technology, sports, and people. Connect with me on Facebook and Instagram!