How to Save a Down Payment to Buy a Home, Part 2
Savings tips to build a down payment and the best places to keep it.
Saving enough for a down payment to buy a home is one of the biggest financial challenges that many of us face. In the first episode of this 2-part series, I covered how much home you can afford and the amount you typically have to pay for a down payment. Plus, I gave several resources for federal and local down payment assistance.
In this episode you’ll learn smart ways to build your down payment fund and the best accounts to keep it safe until you’re ready to become a homeowner.
How to Save for a Down Payment
Down payment money to buy a home typically comes from savings that you build up over time.
For instance, let’s say you estimate that you’ll need a total of $20,000 for a down payment plus closing costs. You could create a goal to put aside $417 a month for 4 years, or $833 a month over 2 years, to accumulate the full amount.
A common question is whether you should invest down payment funds or keep them safe in a low-interest bank account. My advice is to never invest money that you might need in less than 5 years. That’s because the value of your down payment fund could plummet the moment you find the home of your dreams and leave you unable to buy it.
If you’re not sure when you’ll be able to buy a home, or know it will be within 5 years, keep your down payment in a high-yield, FDIC-insured bank account, like a savings, money market, or certificate of deposit (CD).
If your time horizon is longer than 5 years, consider investing your down payment in a low-fee index mutual fund or exchange-traded fund that offers broad market diversification. These are widely available at online brokerages such as:
Related Content: 8 Tips to Invest Without Too Much Risk
5 Money-Saving Tips
You’ll probably accumulate enough for a home down payment sooner than you think if you trim the fat out of your budget or find additional ways to earn more. My book, Money Girl’s Smart Moves to Grow Rich, gives hundreds of ways to make the most of your money and shows you step-by-step how to create and stick to a realistic spending plan.
Here are 5 money-saving tips to turbo-charge your down payment savings:
Saving Tip #1: Downsize Your Housing
Housing takes a big bite out of income. If you move into a less expensive home for a few years you’ll save money on rent that can be used to boost your down payment fund.
Saving Tip #2: Get a Roommate
Saving Tip #3: Make It Automatic
A powerful tactic is to put your savings on auto-pilot. If you have direct deposit at work, have your employer send a portion of each paycheck to a dedicated savings account.
If you don’t have direct deposit or are self-employed, set up a recurring monthly transfer from your checking account to a savings account. If money never hits your checking account, or is transferred out quickly, you won’t be tempted to spend it.
Saving Tip #4: Bundle Services
While you’re saving for a down payment, consider canceling services like a telephone landline or cable TV. If that’s out of the question, find out if there’s a less expensive plan or opportunity to bundle services and save.
Saving Tip #5: Shop Insurance
If it’s been a while since you shopped and compared prices for insurance, this is an area where you could really be leaving money on the table. Use online sites like insurancequotes.com or autoinsurancequotes.com to get free quotes from top insurers so you can cut the cost of your insurance.
Related Content: How to Save Money on Groceries
What Is a Lease Option?
Besides building up your savings, a creative way to buy a home is called a lease option.
A lease option is an agreement between a tenant and a homeowner that allows you to rent a property with the option to buy it. The owner may charge you a premium for the option, such as an upfront fee or rent that’s higher than market value.
Here’s a quick and dirty tip: If you sign a lease option, negotiate for the property owner to apply some of your rent each month toward the eventual purchase price. That way, you’ll automatically have down payment funds if you exercise the option to buy the property. If you decide not to buy, any premium you pay is generally forfeited.
The term of a typical lease option agreement is one to 3 years—but can be any period of time that you and the owner agree on. The purchase price of the home can be established at the beginning of the agreement or when the option expires.
If a seller owns a property outright with no mortgage debt, he or she may be willing to offer owner financing. In this situation, you make loan payments to the owner of the property, instead of to a bank or mortgage company.
A huge benefit of owner financing is that you don’t have to go through a rigorous and strict mortgage approval process with a financial institution. However, the interest rate a seller charges may be higher than the going market rate—so be sure to weigh the pros and cons of a seller-financed deal and seek the advice of a real estate attorney.
Ask a real estate professional about which properties on the market have the potential for creative financing. Landing a lease option or getting seller financing can be the key to buying a home with very little money down.
Using Retirement Funds for a Down Payment
Another way to come up with down payment money to buy a home is to tap a retirement account, like an IRA or 401(k). In next week’s episode we’ll cover the retirement account rules and whether raiding them for a down payment is a good idea.
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