Ask the Readers: What’s the Best Way to Save for a Down Payment?
Monday, 11th June 2007 (by J.D.)This article is about Ask the Readers, Budgeting, House and Home, Planning
When I asked recently for topics you’d like to see covered at Get Rich Slowly, many of you expressed interest in learning more about how to purchase a home. Jason sent the following question:
What’s the best vehicle to save money for a house? I’m probably more than a year from purchasing my first real estate. While maxing out my Roth IRA and building a nice emergency fund, I need to start saving specifically for real estate.
Besides a certificate of deposit, what’s the best way to maximize my house savings without investing in a long-term mutual fund or gambling at stocks? Is it using an online savings account? It seems like the answer should be more complicated than that.
I suspect most people save for a down payment through a simple savings account. Nowadays that doesn’t pay a lot, but it keeps the money safe. By using an online high-yield savings account, you could earn a greater return on your money while it waits to be used. In a Get Rich Slowly forum discussion about medium-term savings and investment, pf101 suggests using target-date mutual funds for goals like this.
Kris and I have purchased two houses. We didn’t save for either. We bought our first home directly from the seller. He agreed to accept a minimal down payment ($1000), and we financed the rest. Our second home took us by surprise. We hadn’t been planning to move, but when we stumbled upon our dream house, we rushed into action. We didn’t have anything specific set aside for a down payment then, either. We had to pull $5,000 out of Kris’ savings — back then I didn’t even have a savings account — to make the down payment.
What about you? How did you save for your down payment? Do you have any tips or tricks to offer Jason so that he can earn more on his money?
I am using a combination of savings bonds and an online high-interest savings account. What I like about the savings bonds is that is a little bit harder to cash in the money, but I could if I really had to.
I didn’t actually save for my deposit either. I was fortunate enough to get a large bonus from work (like a golden handshake) that covered almost the entire thing. The rest has come from my general savings account.
I used a high interest postal savings account because it prevents me from accessing my money too quickly but there are no actual limits on withdrawals.
I think its more complicated if you are about 5 years away. In that case you might want to put some of the money into a more diversified portfolio, especially if you think that inflation is going to have a large impact.
I’ve been stashing away a rather sizable chunk of my paycheck (about 25%) to ING every other week. My understanding is that it’s ok to stop maxing out all retirement vehicles and putting a little extra towards a down payment, so long as you don’t totally ignore retirement. For example, I still contribute enough to my 401(k) to get the maximum company match. However, I am not contributing beyond that or contributing to an IRA.
I used ING. I didn’t have a target date for exactly when we would buy a house, so keeping the money liquid was important. My goal was to have enough for a 25 percent downpayment, high enough to avoid having to pay private mortgage insurance. As it happened, the rules changed a month ago in Canada and now you only need a 20 percent downpayment to avoid mortgage insurance, and by a stroke of luck we stumbled upon our dream house at the same time. I had (literally) just enough in ING to make a 20 percent downpayment, so we went for it. We got our mortgage through ING as well, and even our home insurance.
For Canadians, they can use their RRSP (similar to your 401k) to save, and withdraw tax free when it comes time for the down payment. If you’re interested, i’ve written an article about it here:
http://www.milliondollarjourney.com/how-the-rrsp-home-buyers-plan-hbp-works.htm
House #1 (1999) good old fashioned savings account. House #2 (2004) used signifcant equity from first house as down payment for second house, saved for closing costs via ING. House #3 (2005, investment property) saved for down payment and closing costs via ING.
I sold a lot of stuff I didn’t need any more (bye bye PS 2 and 50 games and hundreds of DVDs and baseball card collection) and put it all into ING Direct, then I started tossing in large chunks of my paycheck each week. It didn’t take nearly as long as I suspected it might.
We figured out what our mortgage payment (with tax, and insurance) would be and spent over a year paying the difference between that and our current rent into a high yield savings account. This had the benefit of us making sure we were not going to be in over our heads once we did have a mortgage payment.
I am about 2 years away from purchasing a house. Right now I am tossing all my extra money into ING, then I toss the money into 4-week treasury bills that get rebought every month. Since I am so young I also plan to empty my 401K for the purchase of my first house (right now I am contributing up to company match in it).
I haven’t had to save for a downpayment but if I did I would use an online savings account like ingdirect, etc and automatically set up a percentage to be deposited from my bank account.
Thanks for this great website,
DT
http://www.debtingthomas.com
I am using ING CDs. My state taxes are high, but not high enough for Treasuries to be worth the hassle. I pick the shortest CD term that is at the highest rate (right now it’s 5.25% for the 9-month CDs). The last time a CD matured, they gave me an extra 0.1% for rolling it over, so I have a CD at 5.35%.
Every time I think of doing something else or rate chasing, ING does something nice like that.
I’ve been dumping a portion of my paycheck into a “relocation fund” (savings at ING Direct) for a few years, but I’ll need to continue doing so for a long time (or raise the percentage) if I want to reach 20% of a typical house in my area.
If you’re in an urban housing market, a down payment is surely in the 5 figures. We purchased our first home in 1975 with wedding gift cash and savings. We were very house poor, and when we went to take our first shower we learned that the water heater was dead. We also realized we needed life insurance, something we hadn’t bothered with before then.
So a word of caution. Don’t cut it too close. there are always unanticipated expenses and surprises with home ownership, and if you’re used to calling the landlord…. those days are over now!
We are using online savings accounts as well, and plan to take 10K out of a Roth IRA (no penalty for 1st time house-buying) that we had set up for this purpose.
Two othe things:
1) I believe that FDIC insures up to 100K, so make sure to open another one once you hit that.
2) ING is great — very customer-service friendly. HSBC is a bit hairier but has better rates — 5.05 to ING’s 4.5 today, and they have promotions. The first 4 months of this year was 6%.
The best way to save a down payment is with the power of focus. My wife and I just bought our first house. We were able to save a 10% down payment in 5 months by simply focusing all our extra money on that one goal.
I know you are thinking, what about goal x, y and z? Well before saving for the house we used this same focus to save up a 5 month emergency fund, this took 10 months. We then funded our ROTH IRA for the year. Since we are debt free we can totally focus on a goal. We have seen the power of not doing anything else but our current goal.
Now we have the goal of paying off the house in less than 3 years. We have a lot of extra momentum from not having a rent payment. A lot of people would call us crazy, but we aren’t too worried. We will save tons of interest (probably only pay a total of $5-7k in interest). I know the tax deduction argument, but there are some flaws with it. Once we are free of all payments then we can turn this same power of focus on our retirement accounts. We will have a paid for everything by the time we are 28 and 29. We can max everything out at that point and still have lots of cash left of for other investing ideas, travel, or anything else we want.
We are making a chart with a house with 100 bricks. Each percent of the loan we pay back we shade in a brick. This helps keep us motivated and see that the end is nearer and nearer!!!
I’ve been saving up for my down payment by putting about $1,000 each month into a non-registered mutual fund, and trying to match that amount in a high interest savings account earning 4.05%.
We were going to do what Mandy suggested in the forum post of using balanced index funds or something like a bond fund. That’s when we thought it was going to be 5-6 years before we looked at moving. However after talking things over with the wife this weekend it looks more like 2-3 years till a move.
So now we’re just going to toss that money into our MMA account for the next couple of years so that we’ll have 20% down (PMI bad!!). One thing I’m not sure about is what’s going to happen to our Roth IRA plans. We were going to open one this month, but now I’m just not sure if we should do that.
Any thoughts folks?
I bought my first home in 1986. I was 26, and I had student loans and almost no savings. I financed at 95% through CalPERS (the state retirement system here in California). The 30 yr fixed interest rate was 14%. I bought the worst house on the best street I could afford, worked like a dog on it for two years, and sold it for a tidy 90K profit, and paid off my student loan.
I see so many of my friends kids buying homes they cannot afford because they “must have granite, 3 car garage”, etc. Scary.
If you have some decent income but little savings, and really want to own a home, you could get into a house with as little as a $1000 down on an FHA loan. Of course the rate will be higher than prime and PMI will be a cost. Don’t over extend yourself on the purchase, save some money for three to five years then refinance and put enough money down to get rid of the PMI.
I don’t think there’s a “good” way to realize more than 5-6% return without significant risks. Someone saving for a house should weigh their acceptable risk and time frame to see if any other investments are worthwhile. Personally, I’m starting to invest my savings in low-risk index and bond funds because it’ll be a long time before I buy a house. (I live in one of the most expensive markets in the country [Santa Barbara, CA] so I won’t be buying a house til I either move or save for a very very long time).
The suggestion about target retirement funds assumes quite a bit of risk because they aren’t set up to free up all that capital at the target date but are supposed to keep enough invested in high-yield investments to provide growth through old age.
A Tax-Free Money Market Mutual Fund is one of the best ways to save for a down payment in my mind (esp. if you live in a state with state income tax). Both Vanguard and Fidelity have state specific MMMF’s that are exempt from federal and state taxes with a tax-equivalent yield usually about 0.5-1.0% higher than the online savings accounts. The only initial drawback is the relatively high initial amount (around $2K if I remember correctly).
Mark down another vote for ING. I’m just piling more money into the same savings account that has my “emergency fund”. I’ve got a $10,000 bonus coming next January, so this January I took out all but $5000 and put it in a 1 year GIC. I doubt I’ll be able to buy then though, the way this market is going it’ll take a couple more years to settle out, however with interest rates the same for everything up to 3 years there’s no incentive to lock the money up for more than one year.
I’m plowing all my extra money into HSBC. I hadn’t really thought about a target date mutual fund, but that’s a pretty good idea too. I’m going to look into it
Mase’s suggestion of tax free MMMF sounded nice but I had no idea what that meant or why it was tax free. For an explanation and how to calculate the equivalent taxable MMMF yield, see
http://www.investopedia.com/articles/02/120602.asp
Vanguard looks to have the most attractive one (no one should be surprised about that): Compare rates http://www.bankrate.com/brm/rate/mmmf_nontax.asp
Vanguard MMMF https://flagship.vanguard.com/VGApp/hnw/FundsSnapshot?FundId=0045&FundIntExt=INT
I must admit I got my house for zero down. Even though I had saved about 6 percent of the transaction price, I found a perfect fixer-upper and put some of the savings into getting the house habitable.
I refinanced a year later to avoid PMI.
If you are only a year out I would recommend using only secure investments such as CSs, savings or money market accounts, or treasury or savings bonds (or some combination of any of these). With only a year or so to go, you don’t have the time to take any more risk than that.
Trent (Comment 7) sold unneeded items to raise more cash; Mike (3) reduced his retirement savings only to the point of receiving company match (only for the short term); Ted (19) mentions FHA loans. These are all good ideas.
Why do so many people use ING? Vanguard’s money market fund has a better yield (unless I’m missing something).
While I think it’s good idea to save money for a downpayment in a savings account, I don’t think if you’re saving for downpayment that you shouldn’t save for anything else. Still toss money into a brokerage account.
We bought our house back in 2000. In the late 90’s, my soon-to-be-wife and I saved up as much as we could in a money market account. When it came time to buy the house, we were short, so I sold off some mutual funds
Carie - Vanguard’s Prime MM isn’t FDIC insured. That means something to some people. Although I seriously doubt Vanguard is in danger of closing their doors. I have 1/2 of my emerg fund in it. Vanguard has a 3k limit and $100 contribution minimum. You also have to sign up for the e-statements to waive the fees.
Note in my FHA example above, appreciation of your home will help you get rid of the PMI. If you purchase a 200k house with essentially zero down, and your house appreciates 6% per year, that will just about cover your 80/20 LTV right there. When you refi you will have to bring money to the table to get rid of the PMI and pay closing costs. But that’s a short cut right there if you can swing the mortgage higher rate for a few years and still save.
31 Ways to Save For a House Down Payment…
Earlier this year, I shared my worries about saving for both retirement and a house.
JD at Get Rich Slowly offered to ask his readers to share their tips for saving for a down payment and, as of this blogging, they've offered up 31 suggestions.
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I am using ING and HSBC. I do like ING’s interface and Electric Orange a little better. But thier interest rate is lower on the Savings side.
I have been looking into FSBO Direct which currently offers 6.0% till Sept.
Am I missing something? To take the other POV from Carie, why would you put short term $ in a MMF? The rate of return for the Vanguard MMF is only 5.11 and for 3 years it states on its website that the return was 3.36, or am I reading this wrong?
About not being FDIC: It’s not just that Vanguard won’t close its doors, it’s that the return isn’t guaranteed. Any given dollar invested could end up being worth less than that. In a savings account, your money is guaranteed.
Please correct me if I’m wrong.
I would say a combination of an ING Direct account and a Treasury Direct account for 28 day T-bills (rates usually slightly higher than ING + tax free).
@Covert7:
Personally, I wouldn’t neglect your retirement savings. Think of the compounding that you can get on the money.
I researched OSA’s and found FNBO Direct (First National Bank of Omaha) to have the highest interest rate– 6% guaranteed until 9/28/07. If it drops lower than 5% after that I’ll definitely put it in something else, but no risk for 6% is pretty damn good. I’m still maxing out my Roth and employer-matched retirement savings– and I’m only making 36k/year.
Holy moly. $5,000 downpayments? Geez, my wife and I have over $150k saved for a downpayment and we still can’t afford a place (San Francisco Bay Area) that we’d be happy to call home. Maybe our standards are too high.
Anyway, the question was about how we saved. We have most of it in a mutual fund with AG Edwards and some in a tax-free interest CD. Accumulating the money though was a combination of rigorous savings each month (we have an auto-savings setup to transfer money) and selling stock at the right time. My wife’s company has an employee stock purchase program that has been a great investment for us.
We also contribute to our 401ks but that’s for another article.
Hi I am saving for a house. Both my boyfriend and I are putting money away in a Roth IRA, this is the first year therefore we just put in 50 each to start, he will add more but for me I am maxing my trad IRA. In 4 or more years will pull out the $10000 each growth plus the money in it. We are both in school I am 23 and he is 26 so not much other saving other than I have what would be my 3 month EF if I moved out. Both of us live with our parents and I save 10% of my pay into a 401k the rest after school, $60/week for gas and fun, goes into a traditional IRA for grad school.
I’m with “momteachingtwo” above - I’m saving the difference between current rent and anticipated mortgage + taxes+ insurance + PMI to be sure we can handle it. Plus any more that is not otherwise earmarked. But I want to add that you should check your bank/credit union for deals. I bank at Digital Credit Union and they have a special account for home buying - $100 min. currently paying 5.5% (higher than ING at the moment). The only catch I can see is that you can only take it out for home purchase, but you don’t need to have their mortgage - just proof of home purchase.
We are saving in ING. Our Capital One High Yield Money Market has slightly higher interest so we may move it. We have a couple of years to go.
Chris, I see you posted that DCU had a special account for home buying, I know it’s been awhile (7 months) but do you know if they still offer such an account? I just looked and didn’t see a thing.
Stephanie - I looked and boy, was it hard to find, but yes it’s still there. Go to:
-Loans/Visa
-Mortgage & Equity
-First Time Homebuyers Saving Plan (American Dream in the Index)
Hope this helps! I like the rates on ING better so my down payment is there, but I like DCU a lot. Good luck.
Chris- Thanks for the help! Looks like the rate dropped to about 3.7 since you posted that last message. Bummer!
My Husband and I have saved an emergency fund of
$10k but are trying to save for a house. We have about $8k in credit card debt that we are trying to eliminate at the same time. Our checking account cushion is $2k. Here is what we are doing: Every time our checking account reaches $3500 ($1500 over our cushion, and after bills are paid of course) we put $1000 toward credit card debt and then put $500 in savings. We live on a TIGHT budget to make this happen. We have 1 car paid for and only $3k left on the other. After the credit card debt is gone in 5-6 months we will be putting that $1500 extra each month into savings and will work on getting the 2nd car paid for. This allows the $2k in our checking to be our first line of defense against emergencies then if needed we can dip into the $10k. Watching our money grow is such a rush and makes us want to be even more frugal. We saved aggressively just for the $10k but now we are starting to lay off the emergency fund until all credit card debt is gone all the while saving more money for a down payment on a house. We each have 401k’s at 6% which meets or exceeds each of what our companies match.
When I purchased my first home, I was able to get an FHA loan with only 3% down. I was in my twenties and not much of a saver. I was fortunate enough to have a husband who could afford all the monthly bills on his own yet I still worked so, we lived off one income and I saved 40,000 on my own over the course of about 4 yrs. Then, for my second home, I made a profit of about 120 k after lawyer/realtor fees etc. When I sold my first home and was able to put 20% down on my second home. My secret…there is none…my advice…keep your credit stellar, and just because you have it…doesn’t mean you have to spend it…it’s all about sacrifice…