How To Save For Your First Down Payment

Saving for a first down payment and building home equity can be a way to build wealth over time. Here’s what you need to know about saving before you buy.

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Buying a home is typically the largest single purchase a person will make in their lifetime. When you are preparing to make a big purchase in real estate, it is important to understand the complexities of what you can afford, what everything will cost, and how to prepare for your purchase.

Your down payment is a one-time cash payment you provide at the closing. The size of this payment has a long-term effect on your finances, as it determines your monthly mortgage payment and your initial home equity.

If you’re still on the fence about whether to rent or buy, consider your timeline. One widely accepted rule of thumb is that you must own the home for around 5 years or more to reconcile the closing costs and transaction fees paid. However, that period depends on where you live and other costs—this calculator on renting versus buying can provide more insight for your decision.

To sweeten the deal, sellers can also agree to pay for a portion of, if not all of, your closing costs to help shorten the timeframe to make up for the portion of costs you're required to pay, if any.

Calculate What You Can Afford

Before you start looking at homes, your first step is deciding what you can afford and what you want from a home. List your basic requirements such as location, size, and other features (for example, a school district).

When it comes to affordability, calculate what your monthly payment will be for the mortgage plus any homeowners association (HOA) fees, taxes, insurance, utilities, maintenance, and other bills. Also remember that, just because a mortgage lender approves you for a certain size mortgage, doesn’t mean you should borrow that much.

If you need help figuring out what you can afford, try a home calculator like this one from Bankrate.

From there, you can look on a site like Zillow or find an agent you trust to help you price home options in your real estate market. The cost of a house can range from less than $100,000 to many millions, and what you can afford is based on your income and savings.

According to Zillow, the typical home value in the U.S. is now at $298,933, which is up 16.7% since June of 2020.

In general, it is a best practice to put down 20% or more when buying a home. At 20% down, you will have an easier time getting approved for a mortgage and will be able to avoid Private Mortgage Insurance (PMI), which is an additional monthly cost for low-equity home owners. PMI can cost hundreds of dollars per month, so it is in your best interest to avoid it.

If you don't have a 20% down payment, you can still buy a house with a lower down payment but you'll just have to pay monthly PMI. Many lenders and states offer loan programs geared toward first-time, low-income homeowners through the Federal Housing Administration (FHA) loan program, or military families through the U.S. Department of Veterans Affairs (VA) loan program.

Some lenders and banks also offer loans requiring less down payment, but you will need to check with them to see if that is an option for you.

The more you put down, the more likely you will be able to negotiate for the lowest possible mortgage rate.

A higher down payment will lower your monthly mortgage payment, and there is no rule against putting down more than 20%. In fact, the more you put down, the more likely you will be able to negotiate for the lowest possible mortgage rate. Remember, you can also deduct mortgage interest payments on your income tax returns.

If you are buying a $220,000 house with 20% down, your down payment will be $44,000.

That is a big cash expense to pay all at once, so start saving as early as possible.

Automate A Savings Plan

Once you know how much you can afford to spend on your home purchase, it is time to start saving. The best option for most people is to save a portion of their paycheck automatically.

You can choose a fixed amount or percentage of each paycheck to get directly deposited into your checking account into an appropriate account, such as a cash savings account or a Betterment investing goal. Save as much as you can so you can quickly build up your balance and make your purchase as soon as you are ready.

At Betterment, you can save for your house using a cash portfolio or investing portfolio, depending on your risk tolerance and when you think you’ll need the money to buy your home.

In addition to your automatic savings, do not forget to save any one-time income—which can further speed up your purchasing timeline. If you get an annual bonus, tax refund, large gift, or side income earnings, save as much as possible to build up your savings even faster.

Building Your Equity

After you have scrimped and saved and made your first home purchase, congratulations—not only are you a homeowner, you are also building equity in your home.

As you pay your mortgage, each month you own more of the property. Over time, your property value may also increase, which adds to your equity as well. If and when you sell your first home, chances are your next down payment will be larger than the sum you started with. It’s just one way to build your wealth.