Published: April 20, 2023 | By: Fortune Recommends
A home is one of the most significant purchases you can make in your lifetime. Not only is buying a home a highly emotional decision, it also requires a lot of planning to make it happen.
Part of that planning includes saving enough money for a down payment and other costs associated with homebuying. So how much do you need? Here’s how to determine how much you should save to buy a home—plus some tips for coming up with the cash.
While you can certainly pay cash for a house, most people need to take out a mortgage to afford a home. Financing property involves several expenses, including closing costs, inspections, and appraisals. But usually, the biggest expense you’ll need to plan for is the down payment.
The actual dollar amount needed can vary widely depending on the exact home you choose, size of your mortgage, type of loan, and how much home you can afford overall.
The average homebuyer puts down about 13% on a home purchase, according to the National Association of Realtors (NAR). However, you may have to put down much less—or much more—depending on your financial situation and budget.
Some borrowers may qualify for a mortgage loan with no down payment requirement. These loans are only available to select borrowers with qualifying properties. Getting a mortgage with 0% down will significantly decrease the amount you need to save up to buy a home.
There are two primary types of zero-down mortgage loans:
USDA loans make it possible for low- and moderate-income individuals and families to purchase single-family homes in eligible rural areas with 100% financing. These loans are offered by private lenders, but are guaranteed by the USDA, allowing for more relaxed eligibility requirements. For instance, there’s no minimum credit score required and no maximum purchase price for qualifying homes. However, borrowers can’t have a debt-to-income ratio (DTI) of greater than 41% and need to demonstrate a history of stable and reliable income to qualify.
VA loans are available to eligible active duty or retired military service members, veterans, and surviving spouses. These loans are also offered by private lenders, and guaranteed by the VA. Eligible borrowers can purchase a primary home with no down payment required, though you will need to meet the individual lender’s credit score and income requirements. Generally, there is no maximum loan threshold and a DTI over 41% may be allowed in certain cases. VA loans may also qualify for reduced fees and lower interest rates than conventional loans.
If you don’t qualify for a 0% down mortgage, you still have options. In fact, it’s possible to put down as little as 3% on your new home.
First, you could consider an FHA loan. This is a mortgage that is secured by the Federal Housing Administration (FHA), a branch of the U.S. Department of Housing and Urban Development (HUD). These loans are intended to make homeownership more accessible for certain borrowers by reducing down payment, closing cost, and credit requirements.
The minimum down payment needed for an FHA loan depends on your credit score:
Additionally, a maximum DTI of 43% is allowed for most borrowers, though some may qualify for a higher DTI with “significant compensating factors.” Further, the mortgage payment shouldn’t take up more than 31% of your gross monthly income. FHA loans are only available for primary residences.
Some lenders of conventional mortgages (i.e., home loans that aren’t part of a government program) may also allow you to qualify with as little as 3% or 5% down, depending on whether you’re a first-time homebuyer. In order to qualify for this level of financing, you’ll need to meet the particular lender’s requirements regarding your credit score, income, loan term, home purchase amount, and more. In general, only borrowers with excellent credit profiles qualify for the lowest down payments.
Finally, you may need to prepare to put down as much as 20% on your home purchase. This is the preferred amount among many mortgage lenders, as the more you put down toward a loan, the less risky it is for the lender. In fact, this is the minimum down payment required to avoid paying private mortgage insurance (PMI) on a conventional loan.
If you do put down less than 20%, you’ll be required to pay PMI until you reach 20% equity, or the midpoint of your loan’s amortization schedule, whichever comes first. This PMI coverage is added to your monthly mortgage payment and helps protect the lender in case you default on your loan.
Annual premiums for PMI typically run between 0.2% to 2% of the total loan amount. So on a $400,000 home loan, you could expect to pay somewhere in the neighborhood of $800 to $8,000 per year for coverage.
By putting down at least 20% on your home, you can avoid the added expense of PMI from the get-go. You may also qualify for a lower interest rate on your mortgage, since the loan presents less of a risk to the lender. But it’s not always the right move.
“It’s true that it is usually worthwhile to avoid PMI by putting more down, but if it means missing out on the perfect home, then maybe not,” says Michael Ashley Schulman, partner and chief investment officer with Running Point Capital, a financial-planning firm. If you aren’t able to put 20% down, “remember to cancel PMI once you are above the necessary threshold in order to reduce payments,” Schulman adds.
Clearly, the lower your down payment, the less you have to save for a house. However, keep in mind that paying less upfront means you’ll end up with higher mortgage payments (or settling for a smaller loan amount, depending on your overall budget). So it’s important to consider whether you prefer to save more now, or spend more in the future.
Here’s a look at what your mortgage payments might be if you want to buy a $400,000 house, based on different down payment amounts (and not accounting for closing costs or other fees).
Now that you have an idea of how much you might need to save for a house—or at least for the down payment—you can come up with a plan to set money aside for this big future goal. Here are some ideas.
Creating a budget is one of the most important steps when setting a financial goal. It helps you see where your money is coming from and going so you can better divvy up your funds.
With a budget, you can:
Once you know how much you can afford to save each month, you can also automate those savings with transfers into a dedicated account. This is known as a sinking fund, where you consistently save money for one-off or irregular expenses.
Once you have a budget in place, you can identify areas where you may be able to trim the fat. By reallocating those funds toward your home savings, you may be able to purchase a property even sooner.
Some ways to reduce expenses include:
Cutting your spending is rarely fun, but it can help you save hundreds of dollars a month if done properly. This can go a long way toward your homebuying plans.
Debt can be expensive and hold you back from other financial goals. “Paying off high-interest debt should be a top priority,” says Jamie Curtis, a global real estate advisor at Sotheby’s International Realty. This is especially important for high-interest debts such as credit cards, which can have interest rates well into the double digits.
If a chunk of your monthly income is going to high-interest debt, consider focusing on paying down your balances first. By refinancing or eliminating these debts, you can potentially save thousands per year, which you can then allocate toward your home savings.
You can also reduce or eliminate the interest charges on your existing debt by:
Sometimes, cutting your household expenses isn’t enough. Or it might not be realistic. Finding ways to make more money is also helpful, and there are a few ways to go about it.
First, consider asking for a raise. If you’ve been in your position for a while without an increase in pay, and you can make a good case (maybe you recently reached a big milestone or helped the company save money), this may be the most effective route. You might also consider asking for a promotion if you’re willing to take on additional responsibilities or roles in exchange for higher pay.
If your employer denies your request or there isn’t room in the budget for a pay increase, you might want to look for a new job that pays more. The Pew Research Center found that 63% of U.S. employees who left their jobs in 2021 did so because of the pay. And 60% of workers who changed employers between April 2021 and May 2022 experienced an increase in wages.
Aside from your day job, there are also ways to amplify your earnings (and boost your savings efforts) on the side.
Taking on a side hustle has grown in popularity in recent years. About 10% of workers today say that they have a side gig in addition to their primary job. To earn extra cash, consider taking on an additional part-time job, doing freelance work, monetizing your hobby, or even renting out your car or a room in your home. Just be sure that whatever you choose wouldn’t present a conflict of interest or breach any noncompete agreements you signed with your current employer.
Aside from your down payment, you’ll need to plan for a few other expenses involved with buying a home. Some out-of-pocket expenses to expect include:
Planning for each of these expenses is important, as is finding the right balance between saving enough money and timing your purchase so it works for your family.
With the average home price climbing every year, buying a home can feel like a massive financial undertaking. Between the down payment, out-of-pocket fees, closing costs, and moving expenses, a new home can easily require many thousands of dollars out of your pocket before you’re even handed the keys.
In order to successfully buy a home in the future, you’ll want to start planning as soon as possible. Research your loan options, sock away some of your income, and look into down payment programs to limit your out-of-pocket expenses. By creating a strong savings plan and reducing your household expenses today, you can make it easier to set money aside and reach your homeownership goals sooner than you might think.
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