Take 20% of the cost of the home you can afford and you’ve got your savings goal.
But buying a home is easier said than done. During the housing boom of the mid-2000s, almost anyone could buy a home with zero money down. Today, it’s a different situation, as lenders have gotten much pickier. The best loans with the lowest interest rates go to people with steady incomes, great credit scores, and that magic down payment of 20%.
On a $250,000 home, the down payment would be $50,000¬¬. That’s a lot of money. You might be able buy with less than 20% down, but your interest rate will likely be higher, adding thousands—even tens of thousands—to the total cost of the loan. You also may be required to buy private mortgage insurance, which is typically 1% or more of the loan amount each year. If you could only swing a $20,000 down payment and had to take out a $230,000 loan, your mortgage insurance would be a minimum of $230 a month. But don’t give up hope. You can get to that 20% with discipline and careful planning. Here’s how.
Open A Savings Account
A savings account is a deposit product that allows customers to safely store their money and earn interest. Savings account deposits are generally pretty easy to access, but funds still aren’t as liquid as they are with checking products. In many cases, money can only be withdrawn a maximum of six times per month from a bank teller or ATM. The required minimum deposit and interest rate will vary depending on the type of savings account you choose. Depending on where you bank, you’ll also have the advantage of federal insurance from either the NCUA (for credit unions) or the FDIC (for banks).
Deposits through credit unions and banks are federally insured through the National Credit Union Administration and the Federal Deposit Insurance Corporation, respectively. Currently, the FDIC and the NCUA offers insurance coverage of $250,000 per depositor, per institution. In the event of a bank failure, you’ll get reimbursed. That’s more protection than you’d get by tucking your savings under your mattress!
While savings account rates highly competitive overall, you can’t argue with free money. The earnings you receive from your deposit is still more than you’d get without an interest-bearing savings account.
Many financial institutions provide overdraft protection, should you accidentally have insufficient funds in your checking account. Through an overdraft protection program, some banks and credit unions will allow you to link your savings account to your checking account. When your account is overdrawn, the bank will pull the needed funds from your savings so that the transaction can continue to go through.
Set a goal
Figure out how much home you can afford. This depends on your income and your current debts, because lenders generally limit the percentage of your income that can go to all debts. If you currently rent, that will give you a rough sense of how much you can pay. (Note that once you own a home you’ll also have to pay for maintenance and repairs, property taxes and homeowners insurance.) Take 20% of the cost of the home you can afford and you’ve got your savings goal.
Build a budget
A budget can help you see how much money comes in, how much goes out, and what’s left over. Make it realistic—look at your actual bills and paychecks—because if you just guess, you’ll almost certainly underestimate how much you spend and how much you can save.
Stop mindless spending
Buying things is very easy. All it takes is a swipe of a card, a click of a mouse, or a tap on a screen. Take a “cooling off” period before you purchase anything other than basic staples. If you’re tempted to buy something, wait anywhere from a few hours to a few days before opening your wallet.
Reduce your debt
If you’re paying a lot of high-interest debt, like for a credit card, take care of it. That money can then start going toward your savings. What’s more, most lenders won’t even consider you for a loan unless your total debt is below a certain percentage of your income. Typically, lenders say your total debt—including home expenses, credit cards, student loans, and the rest—should not exceed 36% of your income before taxes.
Minimize your expenses
Take five of your big monthly bills—heating and cooling, cable, and cell phone possibly among them. Talk to friends and family, go online, or work with the service providers to learn how you can reduce each one.
Consider opening a bank account just for your down payment. Set up automatic monthly deposits into that account. They should occur just after your paycheck is deposited into your primary checking account so you’re not tempted to spend the money. Alternatively, perhaps your employer could divide your paycheck between your checking and savings accounts from the start.
Even if you don’t make it to the magic 20%, reducing your debt and accumulating a decent-sized down payment may help to get you approved for a loan and lower the interest rate you’ll be offered. Money moves like these can also help spruce up your financial picture overall.