Saving money for a house on an average salary can feel like a herculean task.
While it may take some time to save up enough for a down payment and closing costs, you can make it effortless by saving automatically.
Here's how to save money for a house, whether you're buying next year or in five years.
You'll need to have an idea of how much your ideal home costs before you can figure out how much to save. Whether you're planning to stay in the same area, move to a new city, or even cross state lines, research home prices on a site like Zillow, Trulia, or Realtor.com to get a sense of the average price per square foot in the area. A 2,500-square-foot home in Austin, Texas, will run cheaper than the same-sized home in Los Angeles, for example.
The US government offers home loans for homebuyers in a financial squeeze, but of course, there are some tradeoffs. The Federal Housing Administration (FHA) loan allows buyers to put down just 3.5% of the purchase price, but requires a credit score of 580 or higher and a debt-to-income ratio below 43%. If you have a credit score between 500 and 579, you have to put down 10%.
FHA loans are a good option for people who can't come up with the cash for a large down payment, but they do require private mortgage insurance - including an upfront payment plus monthly payments - and will also usually come with a higher interest rate. The maximum loan amount varies by location, but can be as high as $726,525 in a high cost area in 2019.
Active and former members of the military have access to the Veterans Affairs (VA) loan to finance a home purchase up to $484,350 in 2019. This loan requires no down payment and no mortgage insurance, but comes with strict guidelines, including abiding by the "minimum property requirements" standard.
If you're planning to take out a conventional mortgage, most financial experts recommend aiming for a 20% down payment to avoid paying extra each month for private mortgage insurance. PMI can cost anywhere from 0.3% to 1.2% of the loan's principal balance, and is commonly paid to the lender as part of the monthly mortgage payment.
If you feel like it may be impossible to save up 20% of the purchase price, you're not alone. The typical millennial homebuyer put down an average of 8.8% of their home's purchase price as of December 2018, according to Realtor.com data.
Suppose you want to buy a home in the $400,000 to $500,000 range. A 10% down payment would require paying more each month for private mortgage insurance, but would only require $40,000 to $50,000 up front. For a 20% down payment, you would avoid mortgage insurance payments but need $80,000 to $100,000 in cash to complete the purchase.
The down payment isn't the only upfront cost of buying a house. There are fees for the appraisal, the home inspection, homeowners insurance, property taxes, and many other additional costs you'll need cash to cover depending on the home and type of loan you're getting.
According to Zillow, closing costs typically equal about 2% to 5% of the purchase price at an average of about $3,700, although you may be able to negotiate with the lender to cover some of the costs.
Come up a goal purchase date, whether it's one year, five years, or 10 years from now. Knowing how much time you have to save will help break down your savings goals.
Take your goal purchase date and work backwards to find your savings rate. For example, if you want to buy a $400,000 home in five years and your goal down payment is 20% - that's $80,000, plus $8,000 estimated for closing costs. To save a total of $88,000 over the next five years, you would need to put away roughly $1,466 each month, or about $733 per paycheck if you're paid bimonthly ($88,000/24 paychecks/5 years).
Perhaps you're expecting a windfall or plan to put your annual bonus or even a tax refund toward this savings fund. In that case, estimate the annual lump sum you're going to save and subtract that from your total savings goal before calculating how much you'll need to save per month or per paycheck.
Financial experts say the best place to save money for a down payment is in a high-yield savings account or money-market account. Either of these offer higher interest rates than a checking or traditional savings account, helping the money grow while also keeping it accessible and safe. You may even consider choosing a different bank than your primary one so it's really out of sight, out of mind.
If your timeline is longer than five years, you may consider putting the savings into a high-yield CD. The money will be tied up for a specific period of time, but it will stay safer than an investment in the market and earn more interest than a savings account.
The key to any sound financial strategy is automation. When you take the legwork, or the "friction," out of a task, it becomes easier than ever to accomplish.
You should be able to set up automatic transfers from your checking account to your high-yield savings or money market account easily online. Once this is set up, it's hands-off from there.
If you've done the math in step six and don't think you're able to save that much, don't panic. There's nothing wrong with starting small and ramping up your savings amount as you get raises or cut back on expenses or discretionary spending.
Maybe you can only commit to saving $200 a month right now, but you're expecting a raise in the next few months, planning to reduce your housing costs, or finally producing income from your side hustle. Commit to bumping up your automatic transfers whenever possible, and your down payment fund will be growing in no time.
Personal Finance Insider offers tools and calculators to help you make smart decisions with your money. We do not give investment advice or encourage you to buy or sell stocks or other financial products. What you decide to do with your money is up to you. If you take action based on one of the recommendations listed in the calculator, we get a small share of the revenue from our commerce partners.
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