A traditional mortgage generally requires the buyer to place a down payment of 20% of the purchase price, but with recent changes lenders have made it possible to purchase a home with as little as zero down. In order to receive the best possible interest rates and to avoid private mortgage insurance, it is still a wise decision to have a significant down payment, but how can you save tens of thousands of dollars for this purchase?
How Much Should You Save?
The magic number that is most commonly referred to is 20%. At this point lenders will not require you to purchase Private Mortgage Insurance (PMI). The PMI is an additional cost built into your mortgage that protects the lender in the event of a default. Generally you can cancel this insurance once you have built up 20% equity in your home.
Ideally you would like to be able to save up a 20% down payment but that can be a daunting task. Even with a home priced at $200,000 you are looking at coming up with $40,000. The good news is that if you do come up with a substantial down payment you have instant equity in your home which can be valuable down the road when you decide to sell the home.
Don’t let the 20% rule keep you from owning a home though. While it is to your advantage to save money by avoiding PMI and to build equity into your home as quickly as possible you may be able to find the home of your dreams and save money with a smaller down payment.
Sources of Down Payment Funds
When you begin to plan for the purchase of a home there are many possible sources for these funds. Typically the down payment will come from a source of cash savings but there are other options available.
Check with the Federal Housing Administration or Veteran’s Administration as well as state housing authorities for programs that can assist first-time and low to moderate income families to obtain a mortgage with a lower down payment. The U.S. Department of Agriculture’s Rural Housing Service also offers a program intended to encourage low to moderate-income buyers to purchase in rural areas.
If you currently have money saved up in retirement accounts there may be additional resources available to you. Some 401(k) and 403(b) retirement plans allow participants to borrow money from the account for a new home purchase. Additionally, if you have an IRA account there are provisions to allow withdrawals for first-time home purchases.
Put Your Savings to Work
If you are saving money for a down payment you want to make sure it is working for you. Money that is sitting in a savings account earning less than 1% interest won’t do much in regards to helping you reach your savings goal faster. If you have a time frame set for when you plan on purchasing the home there are a few options for your money to make money while you wait.
If your plan is to purchase a home within the next few years you may want to look at a high-yield savings or money market account for holding the down payment funds. Currently you can receive rates upwards of 5% APY on these types of accounts. Another option could be to put the money into a certificate of deposit (CD). You have less flexibility and liquidity with these accounts but the yields can be attractive as well.