House downpayment

How to save for a down payment on a house

Jan. 7, 2019

1525 words long, 7 minute read

Creating a plan to save for a down payment on a house is hard. Between student loans, higher costs of living, and other forms of debt it's no wonder that millennials aren't buying houses. In fact, we are buying houses at more than 8% lower rate than any generations before us!

High house prices are another contributing factor to making saving enough difficult. The average price of homes sold across the US is $225,900, meaning a 20% down payment is $45,180! With prices so high, saving up for that first down payment can take years of discipline and hard work. This is where building your house saving plan becomes crucial.

Below are the steps you can take to building your plan to save up for a down payment on a house. Everyone's plan will look a little different and this is by no means exhaustive. Use it as a framework to help guide your decisions to think about where, why, and how you are going to buy your next home.

Establish your budget

Going in to the house hunting process without setting a budget can make finding a house a nightmare. Without a set price range, it is nearly impossible to search effectively. No budget means you aren't sure what you are looking for and probably should think about what you are looking for more. 

If you have a partner who will be purchasing the home with you, it is even more important to have a set budget. Agreeing to expectations on location, house size, etc. (all factors that feed into a budget) is key to keep everyone on the same page in the house buying process.

If you are flexible, your budget can have a bit of wiggle room. I suggest not going over 5-10% of your preferred budget range. Anything more can lead to overspending on a place you didn't plan for. Here are some ways to help establish your budget when you are first looking.

house prices

Find house prices in your area

There are many house searching sites on the web. My two favorites are Redfin and Zillow. Their interface makes it easy to quickly scan large areas to get a feel of what house prices are. I like starting out at a city-level view to get a real idea of what the costs in different areas look like.

To get a more accurate picture of what the houses have actually been selling for, filter by recently sold. Most real estate sites have a function that can show you houses that have sold in the last month or two. Use this to see if houses are going for the asking price, or if they are selling for more.

Filter by house size and location

Once you have an idea of the general landscape of what houses cost, zone in on the areas you want to be in. Also filter for the size of house you want. The reason I do this as a second step is to try and gauge if the neighborhood I want is expensive, cheaper than average, etc. It's more for context than anything, but can help drive the decision process. For example, you might have seen you can get twice the house in a near suburb vs in the city. If you hadn't looked at the full range of house prices you wouldn't have that context to help drive your budget decision.

Estimate the down payment

Once you have a budget picked out, you need to estimate how much you need as the actual down payment. To estimate this there are two possible scenarios for a down payment:

  • Putting down at least 20% of the house price
  • Putting down at least 5%, but under 20% and paying mortgage insurance

Putting down 20% is the traditional school of thought. It saves you from paying extra mortgage insurance. It also has the added benefit of ensuring you have a lower monthly payment given that your total loan will be smaller.

The reality, especially with house prices these days, is that many people don't have 20% to put down. It could take 5-10 years to save 20% for some of the house prices out there. The other option is to pay 5%-19% of the sales price as a down payment. You will have to pay PMI, which stands for private mortgage insurance and is required by most banks if you are doing less than 20% of a down payment. It is essentially a fee that banks assess to make up for the added risk they take on for not doing the initial down payment of 20%.

The math is pretty simple to figure out the two different possibilities. Use the following formula:

House price x percent needed for down payment

Let's start an example of buying a house for $250,000. To do a 20% down payment the math would look like this:

$250,000 x 20% = $50,000

A 5% scenario would look like this:

$250,000 x 5% = $12,500

You can see how big of a difference the 5% vs 20% are. You can often save a down payment much faster at the 5%. It is up to you to weigh if you are willing to pay extra in mortgage insurance for the shortened timeline.

Create a savings plan

Now that you know how much you need to save for your down payment, it's time to make a plan. Take a look at how much you think you can put towards your savings goal per month. If you are dying to buy a house, you could consider shifting some of the percentage you put towards investing towards the house instead. If you aren't as concerned with buying a house ASAP, try to see where you could shift your budget to save instead.

Remember that you will likely need this cash in the near-ish future. Investing it in the market is riskier on a shorter time horizon like this. Instead, consider a high yield savings account to store your down payment in. This can often yield around 2% a year. Using this type of account will still give you a bit of growth, but not as much as you would have if it were invested in the market. The plus is that you can have quick access to your cash if you find a house you like.

Determine how long it will take you

You can use our savings goal calculator to estimate how long it will take you to save for your house. Make sure to use the correct percent in interest that  you would get in your savings account. For our example, we will assume a middle of the road 1% interest rate on our account. 

Sticking with the example from above, let's estimate the time to save for both a 20% down payment and a 5% down payment. Here are the assumptions for our estimate:

  • can save $750 a month towards the down payment ($9,000 a year)
  • 1% growth rate (very minimal because in a savings account)

Here is what the graph looks like to reach 20% ($50,000):

Future Amount: $50,000 | Additional yearly: $9,000 | Growth Rate: 1.0%

Value after 6 years: $55,921.82

And here is the graph to reach 5% ($12,500):

Future Amount: $12,500 | Additional yearly: $9,000 | Growth Rate: 1.0%

Value after 2 years: $18,270.9

To reach $50,000 in this scenario it will take you between 5 and 6 years. $12,500 only takes around 2. You can see why many are opting for the 5% down payment instead of the 20%. Determine what is the best fit for you timeline wise and then start saving.

Execute

This is honestly the least glamorous part. Once you have the numbers and your plan in place it's time to stay the course. This part can feel really boring. Once you have things set up, it's all about contributing the money for as long as it takes to reach you goal.

Automate your savings

Automating saving for your down payment for your house is easy. Most employers and banks now offer a way to contribute specific amounts of money to an account. I suggest setting up a completely separate account for your down payment so you aren't tempted to touch it. I am a big fan of Simple bank, which allows you to easily create a savings account, has goal tracking, and has auto-contribution features. No matter where you bank, I suggest doing the automation strategy because it really helps you keep on track.

Do the time

Using the estimates from our savings goal calculator, it's time to do the time. This means just staying the course for as long as it takes to reach our goal. If you are able to save more, great! Periodically check your balance and run the numbers again on the calculator to see if your timeline is changing. You might surprise yourself how much you can sock away when you are motivated to reach a goal.

The framework for saving for a down payment on a house is very straightforward. The upfront research is the most dynamic part and the rest is building a system and sticking to it. The time to save a down payment can take a while, but is also very rewarding for those of us who want a house. Use this framework as a guide to help you figure out how to save for a down payment on your next house.

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