Saving for a house: How to prepare your finances
Buying a house is the biggest and most complex purchase most people ever make. Developing a plan a year or more before you’d like to move in can help you buy a home with confidence.
Preparation begins with getting your finances in order. Start by paying off credit card debt and other debts. Set a realistic budget, cut unneeded expenses and start saving extra money for your down payment.
Building a down payment fund that’s appropriate for the house you want to buy may take a few years, but it’s worthwhile. The size of your down payment affects how much home you can afford and the interest rate you can negotiate for a home loan.
Why saving for a down payment is important
Figuring out how to save for a down payment, especially one large enough to help you qualify for a lower interest rate, may seem like a daunting task. But it really is achievable with the right planning and commitment. Plan to put away a set amount of your income each month in savings, and then add what you can to that amount by trimming back on unnecessary expenses like eating out. It can accumulate quickly and be well worth it when the time comes to buy a house.
Here are the top reasons why saving for a significant down payment makes sound financial sense:
- You become a better credit risk. Making a large down payment can increase your investment in your new home, which can make you a better credit risk for your lender because you have more at stake. Having more equity in the home may help you qualify for lower interest rates for a mortgage and other loans you may eventually need, such as auto loans.
- You pay lower monthly payments. The less you borrow, the less you must repay, and the lower your monthly mortgage payments will be.
- You can avoid PMI premiums. When your down payment is at least 20% of the purchase price of your new home, you may not be required to buy private mortgage insurance (PMI). With PMI rates typically ranging from 0.58% to 1.86% of your loan, avoiding this expense may save you thousands of dollars per year.2 If your down payment is lower than 20%, you can cancel your PMI insurance once you have 20% equity in your home.
- You have an edge in bidding wars. When real estate deals fall through, it’s usually because buyers can’t get the financing they expected. Higher down payments indicate buyers have the resources to close the deal. When sellers are evaluating multiple buyers, those with higher down payments have a competitive edge.
How much do you need for a house down payment?
In 2023, the average down payment was 8% for first-time buyers and 19% for repeat buyers.3 The amount you’ll pay depends on several factors, from your financial situation to your chosen mortgage. Understanding how different kinds of mortgages impact your payment schedule is critical here. These are a few of the most common:
- Conventional Loan – These are loans that adhere to the requirements of Fannie Mae and Freddie Mac. Most buyers with a conventional loan opt for 15 or 30-year repayment plans and may have down payments as low as 3%.4
- Federal Housing Administration (FHA) Loan – FHA loans are backed by the Federal Housing Administration and offer buyers with lower credit scores an opportunity for homeownership. Buyers can get down payments as low as 3.5% if their credit is at least 580.5
- US Department of Veterans Affairs (VA) Loan – VA loans are backed by the US Department of Veteran Affairs. They are available to some veterans and active-duty servicemembers and do not require any down payment.6
- US Department of Agriculture (USDA) Loan – USDA loans may be offered to buyers who are moving to certain rural or suburban areas. These loans do not require any down payment.3
- Jumbo Loan – Jumbo loans do not conform to the requirements of Fannie Mae and Freddie Mac. They are often used for particularly expensive properties and may require higher down payments depending on the lender.7
5 tips on how to save for a house
Now that you’re aware of the importance and benefits of planning for homeownership, here is a step-by-step guide on how to save for a house.
1. Create a budget
Knowing how to budget for buying a house is an important first step. You’ll need a solid understanding of where your money currently goes and what changes you might need to make to be prepared for the expenses that come with purchasing a home and home ownership.
Determining what you can afford when you’re looking to buy a home will give you confidence that you can comfortably make your monthly payments down the road.
If financial planning isn’t your forte, think about the 28/36 rule. This rule advises that homeowners should use no more than 28% of their monthly income on mortgage payments and no more than 36% on total debt payments (this includes car payments, credit cards, student loans, etc).8
How to determine a budget for buying a house
Determine household income after tax
Household income after tax can be found by subtracting the total amount you pay in taxes (including federal, state and local) from your gross income (income before any expenses). What’s left is your after-tax income, the amount you have to spend on everything else.9
List your monthly expenses
A spending tracker can help you determine and prioritize your monthly expenses.
Separate these expenses between essentials and non-essentials. If you find anything particularly expensive on the non-essential list, consider cutting it. Even if there are no large expenses on this list, cutting just a few small, non-essential items may end up saving you a decent amount.10
Pay off debt
Paying off your short-term debt can help you focus on other financial goals, like buying a home. It could also improve your credit score, which impacts your mortgage loan approval, as well as the interest rate and other costs you pay on that loan.
The credit score you need to get approval on a loan varies depending on the kind of loan you’re applying for. Usually, you’ll need a score of 620 or higher, however some kinds of loans like VA or FHA may be approved with a score in the 500’s.11
Determine the down payment and closing costs
The size of your down payment often affects how much home you can afford and the interest rate you can negotiate for a home loan. Again, you can typically avoid private mortgage insurance with a down payment of at least 20%, which saves you money on your monthly payment. National averages show many people do not take this route, however. According to the National Association of REALTORS®, the average down payment in 2023 was 8% for first-time buyers and 19% for repeat buyers.3 Despite the favorable terms some lenders are willing to offer, spending more upfront to save in the long term is often worthwhile, if you’re able to do it.
Determine other recurring expenses
When you’re considering your budget for buying a home, you’ll want to factor in the recurring expenses that come with home ownership. Lenders often require borrowers to have homeowners insurance and you'll need to pay property taxes. In addition, you’ll need to pay utilities, maintenance, and other expenses like HOA fees that may depend on where you live.12
Add up all expenses
Now that you have an idea of the costs and expenses that come with buying and owning a house, add them up and use that amount to help you determine how much home you can afford. If you find that you can’t afford your dream home, just remember that buying a home within your budget may give you better peace of mind and more financial flexibility.
2. Determine when you will purchase a home
Saving for a house takes time, and having a realistic timeline will help you plan for and achieve the financial goals you set. If you allow yourself several years to save, that could mean a bigger down payment and all the benefits that come with it. If you are looking to buy a home within a shorter timeframe, however, you’ll want to develop a more aggressive savings strategy, or budget for a less expensive home.
3. Make a savings plan
Savings plans encompass a long list of things you can do in your everyday life to increase savings and hit a financial goal. Budgeting and expense-cutting may be a great place to start, but you can go further to maximize your savings. You can automate savings deposits with your bank to keep yourself honest, choose savings accounts with higher interest rates to grow your money faster and consider secondary sources of income to increase cashflow.10
4. Reduce expenses
As you work through how to save to buy a house, consider traditional and creative ways to save money. Packing meals for work, keeping your car an extra year, using the library, and opting for a staycation provide easy and temporary spending cuts that can help you save significantly more.
5. Start a side hustle
A side job is a very effective way to increase your savings, especially if you’re able to put all or most of your income directly into your savings account. Consider your skills and hobbies to find a good fit that pays well – such as tutoring, photography, or woodworking. If you want even more savings, a side job can take the place of a membership or subscription you no longer need. For example, you could get your exercise from dog walking instead of paying to use the treadmill at the gym.
Developing a plan to buy a home and saving for a down payment can help establish a savings pattern and trigger conscious decisions about debt that will serve you well throughout your life. When the actual house-hunting process begins, you will be prepared and able to move quickly when you find the right house to call home.
Once you reach your goal and buy your home, it’s time to think about safeguarding your investment. Get an obligation-free homeowners insurance quote from Nationwide, and start protecting your home for all the years of happiness ahead.