Buying a house is exciting. It is also very expensive. Long before you start shopping or fill out a mortgage application, you need to save money. This money pays for the down payment. Conventional loans offer the best terms for those who put down at least 20 percent of the price of the home. This is not reality for many people, though. Luckily there are other programs available. The FHA requires 3.5% down and Fannie Mae implemented a program that requires just 3% down. There are also government-backed USDA and VA loans, neither of which have a required down payment.
No matter which program you choose, you must save money. Even if you don’t need a down payment, you will have closing costs. You may need thousands of dollars before you can ever start shopping for a home. So how do you start? Here are a few simple steps.
Look at Your Budget
First, you must look at your budget. What can you afford to save? Closely look at your monthly expenses. Don’t overlook little things like daily coffee trips or shopping sprees, either. Make note of any habits you can possibly change and the dollar amount you would save. Then take an honest look at what you can save. If you already overspend, saving might not be easy. Starting with your budget gives you a bird’s eye view of where you stand. Then you can move forward with your plans.
If you have to make changes, start small. For example, giving up daily lunch runs at work will take time. If you have to start packing a lunch, don’t expect to be able to do it 5 days a week. Start small – maybe bring your lunch twice during the first week. This way you ease your way into your new habits. Once you see how much money you save in just one week, hopefully you will pack lunch more often.
This is just one way you can switch up your habits. Small habits can add up to big savings, especially when you change several of them at once. Once you have a little extra money, it is time to start saving.
Open a Savings Account
Don’t wait too long before you open a savings account. If you let the extra money sit too long, it will be very easy to absorb it right back into your regular spending. We suggest automating your savings. Once you looked at your budget and know how much you can save each month, have that money automatically deposited in your account. This way it is “out of sight and out of mind.” You can act like the money never existed.
Bank your Windfalls
This one is big. Let’s say you receive a tax refund of $3,000 this year. Before you spend it the moment it is in your hands, have a plan for it. The best plan is to bank it! Put that money away. Suddenly your small savings account just jumped $3,000. If you make a habit of banking any windfalls, you will get to your goal faster. A few other examples include bonuses, refunds, or inheritances. Any large sum of money that you don’t count on for regular income should be put right into that savings account.
Don’t forget the power of raises, too. If you get a significant raise, consider banking at least a portion of that amount. Up until the point you got the raise you were used to living a certain way. Keep those ways and put the money away. This may help you reach your goal even faster.
Bank Your Gifts
Do you receive monetary gifts from friends or family for specific holidays? Again, this is unexpected money. Don’t spend it. Instead, put it right in the bank. If the deposits are large enough, they may need to be seasoned. This means sitting in your account for a certain amount of time. Most lenders require at least 6 to 12 months of seasoning. This is especially true if you have a family member or friend who gifts you money to purchase a home. The lender must determine that it was a gift and not a loan. This is why the seasoning is so important.
If your friend/family member does gift you the money right before you purchase a home, they can write a gift letter. This letter simply states that the money is a gift and the person giving the money does not expect repayment. The letter must also state the exact reason for the gift, such as purchasing XYZ property.
If you have a large amount of debt out there, consider consolidating it. This way you may save on interest charges. With one payment, you can pay the balance down faster. Any money you save on the payment, you can put away towards the down payment for your home. Of course, if you have debts with 0% interest rates, don’t mess with those. Consider the debts with the higher rates that have you paying hundreds of dollars in interest each year.
Consider IRA or 401 K Loans
While it is not recommended, you may have the option to borrow from your IRA or 401 K. If you are a first-time homebuyer, you may be eligible to borrow up to $10,000 from your IRA. If you have a 401 K, you must check with your HR department to see how a 401 K loan works. We recommend using this as a last resort, though. Retirement funds should be left for retirement, but in a bind, they can be helpful for your home purchase.
Keep in mind, though, any money you withdraw early from your retirement account will be subjected to income taxes. If you stay within the limits, you likely will not pay a penalty, but the taxes may add up.
Saving for your down payment on a home takes time. The best thing you can do is start early. Before you even think you want to purchase a home, start putting money away. The larger down payment that you have, the more loan options you will have at your disposal. While there are programs that offer just 3 or 5% down payment requirements, the more you put down, the lower your interest rate. You may even have lower fees with a lower down payment just because of the lower risk you pose to the lender. Implement these strategies and start saving today.