We all dream of our first real estate purchase from an early age. As little kids, we imagine huge castles and glowing palaces where we would live among our favorite noblemen, princes, and princesses. Later, after mastering the rules of Monopoly, we become real estate tycoons. And as the years go by, we keep downsizing. By the time we finish college, we would call ourselves fortunate if we can afford a 1,000 square feet condo or a cute tiny house. The harsh reality is that the school system provides little to no financial education and doesn’t prepare us for the economic reality we are going to face as soon as we graduate. So it’s OK to ask yourself: “How to save money for a down payment on a house?”
While the banking system is not adding value to our daily lives, the real estate market greatly depends on it! Americans have become accustomed to borrowing from their future. That pushes them to work longer hours for the same money. There’s now an overwhelming array of loans that you should know about. So the banking system is a necessary evil that you must understand before you set up a down payment savings account.
During the home buying process, most lenders will ask where your down payment money came from. Using other types of loans as a down payment is hard and not recommended. Lenders want to see that your money is seasoned. In other words, they want to see that you have worked hard for that money and they stood in a bank account for a while. This speaks volumes about your financial intelligence.
When to start saving money for a down payment?
As soon as you get paid. You can (or could?) start saving as a child, when your parents pay you to do household chores. Saving is a habit that requires a lot of practice before it becomes a routine. If you had come across the theory of Maxwell Maltz before, you would have already known that habits form in a minimum of 21 days but according to Phillippa Lally, a health psychology researcher at University College London, it takes 66 days for a new behavior to feel automatic. Depending on the habit you want to acquire in your life, it might take even longer.
Saving money demands commitment. The sooner you start, the better. I wish that there had been a golden rule in place for saving money, but there isn’t. One thing is for sure: it takes time to save money. Take this into consideration!
Discuss your housing needs with your parents or with a loved one and see how you can go about it. If you get some financial help from your family, like a loan with no interest to serve as your earnest money, then you can start looking for a real estate agent right now!
You should save money for your house either in a down payment savings account or in a piggy bank even if you choose a VA or an FHA loan! Look at that money as an emergency fund for unpredictable events – a way to cover your mortgage payments for a few months or up to a year. Or, you can use your savings to pay more off your principal every month! In this way, you will pay less interest on your home loan.
How much should you save for a down payment?
If you only qualify for a mortgage with a 20% down payment, then let’s find the best approach. According to the Bureau of Labor Statistics for 2018, the median pay of those 25 or older with a bachelor’s degree was $68,120 a year. So to simplify, let’s suppose you make $5,000 a month. If you are looking for a single family house priced around $250,000, then your 20% down payment on a house would be $50,000.
How long it would take you to save that money? Do you think you can set aside 20% of your monthly income? In this case, it will take 4 years and 2 months to come up with $50,000. Or switch to Senator Elizabeth Warren’s rule 50-30-20. This means you’ll spend no more than 50% on needs and 30% on wants, while the remaining 20% of your income after tax goes to your nest egg. In 2018, the personal saving rate in the US was only 7.6%. At this speed, it would take you almost eleven years! But I bet you can tighten your belt and accelerate your savings. Who said it’s impossible to become a homeowner before you turn 30?
Should you open a down payment savings account?
Here, in the Western world, we have put banks in the center of our lives. But banking has changed a lot since the invention of credit cards and ATMs. Did you know that the Automatic Teller Machine turned 50 in 2017? A device first installed by the British inventor John Shepherd-Barron, the ATM has revolutionized the way people obtain cash. There are 17 ATM operating networks in the US and a mix of bank-owned ATMs and private ATM networks such as First Data and Fidelity National Information Services (FIS). The number of ATMs across the US is around 470,000, but only 40% are bank-owned. According to the Health of Cash study conducted by Edelman and Cardtronics (the largest non-bank network), for 80% of the people surveyed, a world without cash would be absurd.
However, don’t you feel like technology is replacing bank notes with virtual currencies and electronic currencies, making it harder and harder to save money? Studies on consumer’s behavior have revealed “the credit card premium” phenomena – the willingness to spend more when paying with a credit card. We are entering an era in which banks are creating a shortage of paper money, stimulating the spending of electronic money. It has been revealed that paying with a credit card is less painful than paying with cash. So, how to save for a down payment? Give up credit cards and start using cash more often!
As soon as you make up your mind to start saving for a house, start paying off your credit card debt. Try not to get yourself over-indebted. Maintain a debt-to-income (DTI) ratio below 40%, if possible.
If you want to go the extra mile, simulate one month with a mortgage payment. How does it feel? Are you comfortable with it? If you’re doing fine, then, take your saved banknotes every month and deposit the money in your down payment savings account. In this way, you will better understand that a home purchase means a huge investment of your time and effort and a great commitment.
Should you use a personal loan for a down payment on a house?
We wouldn’t recommend this and most lenders do not accept borrowers who do not prove they can afford a long-term loan. You should use a personal loan for a down payment on a house only as a last resort. Every loan lowers your credit score. So, on top of having high monthly payments for a few years, you will pay more interest on your mortgage. Moreover, if you want to make any home improvements, the next loans will get even more expensive. Don’t let yourself seduced by a low interest rate! Whenever you shop around for a personal loan, look at the APR instead – the annual percentage rate – that is the actual cost of the borrowed money. Be aware of the fact that FHA loans also impose a DTI of 43% or less, while those with higher credit scores and cash reserves can enjoy a higher limit of 50%.
How to save for a down payment while renting?
To rent or to buy? Or to rent before you buy? Here are two dilemmas that most home buyers face at some point. With rent being similar to monthly payments on a mortgage, it doesn’t make much sense to rent. To save money while renting, for some of you, it could sound like a huge financial strain. But it all depends on your monthly income. Besides, there are cities where it is better to rent than to buy, depending on the price-to-rent ratio.
Renting might spare you of homeowner’s insurance and property taxes, but you don’t gain any equity in that property either. However, if that is not your goal, you can save money for a home purchase the same way you would have saved money for a tour around the world. Go frugal! This shouldn’t be too hard if you’ve come of age at the beginning of the third millennium. After surviving the 2007-2008 market crash, Millennials know how to live on less!
Paying off credit card debt is also of utmost importance. Try to protect your credit score by paying everything on time and by not breaking your rental lease. To reduce the burden of the rent, look for a roommate! Alternatively, ditch cable TV, get a second job and give up smoking.
Now that you’re here, write down all your monthly expenses and rethink your budget. Imagine that saving is actually an expense. Treat it as if it were your most important expense every month. Set a monthly goal and put the money in the envelope every time you get paid. You can do it twice a month or daily, it doesn’t matter as long as you stick to the plan.
Had you been born with a silver spoon in your mouth you would have spent your time with noblemen, princes, and princesses instead of reading this article about how to save for a down payment. The uneven distribution of wealth is an issue as old as time and it’s here to stay. We can do little to change it. But at least we can do something about it: we can work hard and fight for our dreams!
What do you find challenging about saving for a down payment? We would love to find out so please leave a comment below!