Saving for a down payment can help you be prepared when you find the right home.
This blog will walk you through the importance of a house saving plan and actionable steps on how to save for a down payment. If you have questions about financing your future home, Diamond’s mortgage experts are here to help.
What is a Down Payment?
A down payment is the total amount you pay upfront when buying a home. This initial payment will help outline your future mortgage payments, interest rates, and the total life of your loan.
Typically, once a down payment is made, the rest of the cost is financed with a homeowners loan. Because of this, it’s crucial you put your best foot forward so you don’t have to worry about other additional costs or high monthly mortgage payments.
The Importance of a House Saving Plan
If you’ve been looking at homes or the market for a while, you’ve probably noticed that costs are rising. In fact, the average price of a home in Pennsylvania has increased by 4% in 2023, and history shows a steady rise in the cost of buying a home.
Now more than ever, it’s crucial to have a house saving plan in place so you feel prepared for this next financial step. Especially if you are a first-time home buyer, this can be a daunting decision and without being prepared, you can run into more road bumps along the way.
The fact of the matter is, that the more you can put down as an initial payment, the lower your monthly mortgage payment will be.
By setting up a house saving plan, you can also be prepared to know how big of a mortgage you can afford. As you begin to look at homes, consider the rule of 28. Financial advisors recommend only spending 28% of your monthly income on a mortgage.
With that number in mind, you can start to understand a realistic down payment. A house saving plan will help you balance how much house you can afford and provide you with a full picture of your financial situation.
You can also use a financial calculator to help you answer the question, how much do I need to buy a house? The calculator asks for a few numbers including your maximum monthly payment amount, annual property tax rate, and your loan information.
The Difference a Down Payment Can Make
To further emphasize the importance of saving for a down payment, we’ll provide you with real number examples. Your down payment percentage will depend on your credit score, but with a high credit score, your down payment can be as low as 3%.
At first glance, you may be excited to have the ability to have such a low down payment percentage. However, if you’re only putting down 3%, you can expect higher monthly mortgage payments.
To really see the difference, let’s say you’re interested in buying a home for the average price of a PA home, $256,703. If you put a 3% payment down, that is $7,701. But a 20% down payment equals $51,340.
This is a significant difference in costs, and you may assume that the 3% payment is better for you. But let’s digest this further and consider the amount you’ll be spending over time.
With the smaller down payment, your mortgage would be $249,002. The average interest rate for a mortgage is around 7%. With these numbers, you’ll be spending $17,430 in interest over the first year of your mortgage while paying off your home.
Additionally to these interest payments, you’ll also need to pay Private Mortgage Insurance, or PMI because your down payment is less than 20%.
Now, with the larger down payment, your mortgage is $205,363. So, your interest is $14,375 for the first year. Because you took a higher down payment, you won’t have to pay the Private Mortgage Insurance either.
We encourage you to do this analysis with the homes you are looking at. Calculate what your mortgage would be with different down payments so you get the full picture of the cost.
Tips to Save for a Down Payment
Knowing the importance of a larger down payment and creating a house saving plan helps motivate you to take tangible steps of action. Below, we’ll list our recommended tips for saving for a down payment.
1. Pay Off Credit Debt
As we mentioned earlier, your credit score has a significant impact on down payment percentages and loan interest rates. If you start paying off your credit debt and increasing your credit score, this will make buying a home easier.
Once you’re able to pay off your credit card debt, take that extra money and put it in a savings account for your future home.
2. Use a Dedicated Savings Account
There are specific benefits to opening an account that is dedicated to saving for a down payment. At Diamond, we offer different savings accounts that earn more interest as you have more money in them. Diamond’s club accounts can be opened through NetBranch. As you deposit more, you can transfer your money into a higher earning savings account.
Having a separate account allows you to have better control and knowledge of how much you’ve saved thus far, and how much you still need to reach your down payment.
3. Automate Your Savings
By automating your savings deposits, it becomes a natural part of your budget. Some savings accounts require a minimum initial deposit. However, a club account doesn’t have a minimum amount and you can pull the money out whenever you need it.
Making positive financial decisions helps create great habits across the board. So, these tips on saving can start with your down payment but can expand across other larger financial decisions.
4. Cut Back, Save Big
In the beginning, creating a house saving plan can be daunting. Take it step by step and make small, gradual changes to help prepare for this financial decision.
Consider your budget and if there are any areas you can condense to further save for your future home. As you’re looking at your budget, here are a few categories that are considered unnecessary spending.
- Eating Out
- Shopping
- Gym Memberships
- Vacations
- Streaming Services
If you have some or all of these categories in your current budget, ask yourself how you can trim these costs down each month and put money into your house saving plan.
5. Save Any Lump Sums
Your tax refund, work bonuses, commission checks, or other monetary gifts are great for depositing larger amounts into your homebuyer savings account. This can give you an extra boost that won’t affect your monthly budget.
6. Take Advantage of Tax-Free Gifts
If you’re planning to get financial help from your parents or another relative, they can make a financial “gift” of up to $16,000 without tax repercussions for you or them.
You’ll need to be clear with your lender about whether it’s a loan or a gift. If it’s a gift, you are not expected to pay it back. You will also need to provide a letter that confirms your relationship with the gift giver.
7. Tap Into Your IRA
As a financial best practice, we typically do not recommend pulling money from your retirement account. However, your down payment is an exception. As a first-time home buyer, you can withdraw up to $10,000 without a 10% tax penalty.
Although you won’t receive any penalties on this withdrawal, you still need to pay taxes on it.
Learn more about how to save for a down payment by speaking with our mortgage experts.
